The Long Goodbye to Cheap Oil

Sales of SUVs -- often blamed for the nation's ruinous dependence on foreign oil -- were down in May 30% for General Motors and 19% for Ford. Civics and Corollas took over the top sales spots from big pickups. And GM and Ford executives think the switch to small, fuel efficient cars is permanent, even if gasoline prices go down.

If they are right, there's been a seismic shift in the auto market since last spring. Then, gasoline prices had declined 24 percent in the previous few months while gasoline-electric hybrid sales declined 31 percent. After rising for most of the year, Toyota Prius and other hybrid sales fell sharply right along with the price of gasoline.

These first few years of the 21^st century have had much in common with the seventies and eighties. Oil prices spike, and the world is green again. Oil prices decline, and the market for efficiency and renewable alternatives fades.

We've been through this before. In the eight years following the second oil shock of the 70s — 1977 through 85 — the U.S proved that it could control the world price for oil by controlling its demand. The U.S. gross domestic product rose 27%, while oil consumption fell 17%. U.S. oil imports from the Persian Gulf fell by half, and imports world-wide by 43%. America is such a dominant consumer of oil that the world market shrank by 10%, cutting OPEC's market share from 52% to 30%. This broke OPEC's pricing power for a decade.

We did this primarily by using energy more efficiently — the federal government required new cars to get better mileage — and there was also a nascent renewable energy industry. The U.S. became the world leader in the new energy technologies as oil companies and investors clamored to get in on solar and wind energy. The return of low oil prices swept all that away.

Martin Wolf, the Financial Times columnist, thinks it, "quite unlikely that aggregate demand for oil will collapse, as it did after the two previous price spikes (in the 70s)." Too much demand is coming out of the fast-growing Asian economies. Still, Saudi Arabia is worried. After having rebuffed President Bush's pleas for more production, the world's biggest producer is hedging its bets by increasing output by a half million barrels a day. Nevertheless, something about the current dip in demand feels permanent.

Remember Sheikh Ahmed Zaki Yamani, the Saudi oil minister during the 1970s oil shocks? Yamani is often quoted for having said, "The Stone Age did not end for lack of stones, and the Oil Age will end long before the world runs out of oil." Speaking in Houston last month, Yamani said his advice to OPEC is "to increase production and lower prices because this is harmful midterm (and) long term to OPEC itself. It will increase the activities to find alternative sources of energy, and OPEC will remain helpless at that time." With current prices hovering around US $130, Saudi Arabia may be unleashing a dynamic that could harm its long-term interests, and, says Rice University analyst Amy Myers Jaffe, "at US $200, almost everything works."

It looks like Saudi Arabia will follow Yamani's advice. But could Americans be persuaded that any future oil or gasoline price dips will be temporary, and that prices need to be stabilized at current levels? Some proposals to do this are daring to speak their names. One comes from Philip Verleger, for decades one of the nation's leading experts on the petroleum market. He has proposed a "price floor" for gasoline: US $4 a gallon for regular unleaded. This is still half the going rate in Europe, notes Tom Friedman in the New York Times. What this would mean is gasoline taxes on a sliding scale to smooth out market dips that might bring back the gas guzzlers or render new energy investment unprofitable. Verleger's idea is that the tax receipts could be used to lighten the burden on lower income drivers by reducing their payroll taxes. Or, some of it could be used for massive investment in new energy technologies.

Montana Governor Brian Schweitzer proposed a floor under the price of oil to ensure that synfuel from coal in his state remains economically viable. Financial journalist Eric Janszen suggests a floating tariff on imported oil: "What if by tariff imported oil was held at US $100/bbl no matter what the actual FOB costs and gradually increased to US $200, over say three years?"

But, maddeningly, American consumers can't seem to accept any intervention in the market place that might, however remotely, raise gasoline prices. Californians recently decisively rejected a ballot measure that would have put a severance tax on oil production in the state to finance energy alternatives. Opponents argued, implausibly, that the tax would raise gasoline prices. In fact, it would have been lost in the background noise of the global oil market. Gasoline is cheaper in other states — Alaska, Texas, and Louisiana — which do tax oil production.

What is becoming clear is that the long term trend must be up. The growing consensus is that global oil production has peaked or will within the next few years. With demand growing in emerging economies, such as China and India, pressure on prices will be irresistible. Can American consumers be convinced of this?

Boom and bust cycles have characterized petroleum prices since the beginning of the industry. There used to be a national consensus that this was not a good thing. With full backing of the oil industry, the Texas Railroad Commission effectively controlled U.S. oil prices by regulating production in the biggest oil-producing state. U.S. oil production peaked in 1970, rendering production controls superfluous. Pricing power passed to foreign importers. Worse, most of the importers are now national oil companies with political aims that can take precedence over market efficiency.

We can get back in the driver's seat if we give up the dream of permanent cheap oil.

The case for taking back the world petroleum market using our demand leverage has never been more compelling. Oil is the fastest-growing component of our trade deficit. Our oil import dollars are funding world-wide terrorism. Much of our defense budget is spent for protecting overseas oil supplies. We need to create a new domestic energy economy that will spin off good-paying jobs to replace those which are being outsourced. Despite the nation-wide recession, Iowa reports a job surplus, partly due to the booming biofuels and wind industries there. And, finally we seem to have a working consensus that climate change is real and must be dealt with.

The only thing standing in our way is the long goodbye to cheap oil.