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Who’s Afraid of Expensive Petrol?

Friday, January 25, 2008

Oil price increases have less effect on the U.S. economy today than they did in the 1970s, writes DIANA FURCHTGOTT-ROTH. But we can’t afford to be complacent.

Oil FeatureAs oil prices retreat from $100 to $90 per barrel,Americans are wondering how long such sky-high prices will last, and how they will affect the U.S. economy. The bad news is that oil prices could stay at their current levels for some time. Prices are high due to robust global demand, constraints on production (though not on reserves) in oil-rich countries, and the risk of political instability. Furthermore, since the U.S. dollar has lost much of its value against other currencies, oil prices have risen in dollar terms, thereby giving producers higher real income. Until the dollar stops declining, the upward pressure on oil prices will continue, even if global production expands.

The good news is that the American economy is less dependent on energy than it was in the past. True, if prices stay around $100 per barrel Americans will pay $209 billion more for oil in 2008 than they did in 2007. But these higher prices, while still acting as a tax, will have less effect than in prior decades. 

From 1974 to 1985, the United States spent more than 10 percent of its GDP buying energy. In GDP terms, the peak year for U.S. energy costs was 1981, when Americans spent roughly 13.7 percent of GDP. In 1973-1975 and 1979-1981, the share of GDP devoted to energy increased despite decreases in per capita and total energy use. Since then, even from 2003-2006, per capita energy consumption in the United States has remained relatively steady, between 340 and 350 million BTU per person.                               

The American economy is less dependent on energy than it was in the past. Higher prices, while still acting as a tax, will have less effect than in prior decades.

Beginning in 1986 and lasting through the end of the decade, energy expenditures as a percentage of GDP started to decrease to around 8.0 percent. During the 1990s that ratio fell even further, reaching 6 percent in 1999. The fast-growing information economy had relatively low energy consumption, which helped to reduce consumption as a percentage of GDP.

Energy spending as a percent of GDP didn’t begin rising significantly until real energy prices began rising in 2003. But there are several key differences between our current situation and that of the 1970s.

First, U.S. energy consumption has been fluctuating around 98-100 quadrillion BTU—hardly increasing at the pace it was in the 1970s, where consumption increased by 13.0 quadrillion BTU over a decade. Consumption in 2006 was only 5.7 quadrillion BTU greater than it was in 1996. And we have actually been decreasing our per capita energy consumption since 2004, whereas per capita energy consumption was increasing during the 1970s.

High oil prices are not always the cause of high gasoline prices. Last May, for example, refiners paid about $67 per barrel for oil, but the average price of gasoline in New York hit highs due to refinery shortages. Refineries in Wyoming, Oklahoma, and Texas were not producing at full capacity, and gas stations were switching from winter to summer gasoline blends and cleaning out their tanks.

By contrast, refineries are now back on track (at least until the next hurricane or refinery fire), and today’s high gasoline prices are caused by high prices for crude oil. In order to keep gasoline prices from moving even higher when refineries shut down, the United States needs to build more refineries in order to have some excess capacity. 

Even though our economy is less dependent on energy than it was three decades ago, we cannot afford to be complacent. Many of the alternative energy projects contained in the federal energy bill passed last December will actually make energy more costly.            

Renewable and corn-based fuels are still far more expensive than oil. The new energy bill requires that a specified volume of renewable fuels—higher than the current level of 5.4 billion gallons per year—be used in motor fuel and home heating oil. In 2008, the mandated amount will increase to 8.5 billion gallons; in 2022, it will swell to 36 billion gallons. This will raise the price of gasoline and heating fuels. If renewables weren’t so costly, the government would not have to mandate them.           

(Curiously, the renewable fuels requirement will apply only in the 48 contiguous states. The senators from Alaska and Hawaii are apparently cleverer than their colleagues. Over the years to come, energy in Alaska and Hawaii will be less expensive than in the rest of the country.)

While the new legislation promotes costly alternative energies, it does not help expand domestic oil and national gas supplies. It does not allow increased exploration and development—even with green-friendly technologies—in areas that are now off-limits, such as parts of the Rocky Mountains, the Outer Continental Shelf, the Gulf of Mexico, and the Arctic National Wildlife Refuge. It also bans development in some areas that are currently open, such as Colorado’s Roan Plateau.

The world needs more oil. Global consumption has been increasing steadily—yet in 2007, the annual average world oil supply fell by 268,000 barrels per day compared to 2006. State-owned companies in Venezuela, Russia, Mexico, Nigeria, and even Canada are restricting foreign companies’ returns on investment by raising taxes and royalties and changing the terms of access. Naturally, foreign investment is declining. Until these countries are willing to allow more foreign investment, they won’t be able to increase production.           

When he met with Saudi entrepreneurs in Riyadh on January 15, President Bush was sufficiently desperate to say, “The best way to achieve better understanding in the world is for folks just to get together, and get to understand that we share the same God, and we share the same aspirations for children and for our futures.” This is so patently false—the Bush daughters, Barbara and Jenna, as well as other young American women, are educated, drive, can choose their own husbands, and don’t have to wear heavy burkas—that the president was obviously pandering to the oil producers. Even though energy price increases have less effect on our economy than they did in the 1970s, when our president starts pandering we know we’re in trouble.

Diana Furchtgott-Roth, a former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute and a weekly economics columnist for The New York Sun.

Image by Darren Wamboldt/The Bergman Group.

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