What we need to talk about, really, is where the security vulnerabilities that arise from oil originate.
They do not come from the amount of oil that we im-port. This may sound counterintuitive. However, for the most part, our vulnerabilities with respect to oil would stay exactly the same even if we didn’t import any oil. To illustrate this point, think back to 2008.
Re-member oil prices spiked. At that point, Great Britain was supplying almost all of its own oil. The truckers in Great Britain rioted at that time and blocked the roads.
They did so because oil is a fungible commodity; it’s got a global price.1 The price went up for everybody.
It didn’t matter if you were importing any oil or not.
Our vulnerability thus isn’t really about the amount of oil we import. What it’s about is the fact that oil is a strategic commodity. To understand what that means, we need to look to history. I titled my last book Turn-ing Oil Into Salt, because for centuries salt was a major strategic commodity since it offered the only way to preserve food. Wars were fought over salt. In some cases, countries chose where to establish colonies be-cause of an abundance of salt available. Armies march on their stomach. You couldn’t very well march thou-sands of miles if you didn’t have preserved food.
The world moved on salt at that time. Then, with the advent first of canning and then, still more impor-tantly, electricity along with refrigeration, salt became completely irrelevant to world affairs. Does anyone know whether we import salt? How much salt we im-port? Do you care what the world salt price is? Do you contemplate who the world salt reserve holders are?
It’s totally irrelevant to you. Unless you’re in the salt business, or you’re a buyer or seller of salt, you really don’t care about any of this. Salt is no longer a strate-gic commodity. It’s just another commodity, despite the fact that we consume more salt now than we ever did before. It’s primarily used for clearing snow. But it’s no longer important. It no longer shapes the course of history.
Now, oil sits exactly where from a strategic per-spective salt did years ago. It shapes the course of
his-tory. It shapes relations between countries. Let us be very honest. Would anybody in Washington be using the phrase, “Our friends, the Saudis,” in any other cir-cumstances? No.
Thus we need to think about where oil’s strategic status stems from. It clearly does not stem from our need for electricity. Only 1 percent of U.S. electricity today is generated from oil. Only 1 percent of U.S. oil demand is due to electricity generation. Outside of the oil exporters (in effect the OPEC countries), these numbers are essentially the same globally: 5 percent.
Oil and electricity are two separate issues. I’m reiter-ating this because when you look at polls, 90 percent of the American public believes that solar, wind, or nuclear power will wean us from oil. Ninety percent!
This is a huge disconnect.
When you look at politicians running for office, whether they’re on the left or on the right, you’ll hear calls either to build more solar panels and wind tur-bines, or to build more nuclear power plants. That’ll get us off of oil, they say. That’ll end our imports.
That’ll reduce our dependence. You’ve heard this. I’m not making this up. It’s complete nonsense. Our need for electricity and our need for oil are two totally sepa-rate issues.
Oil’s strategic status stems from its virtual monop-oly over transportation fuel; 98 percent of our trans-portation energy is petroleum-based. Thus, if we look to the salt analogy, to strip oil of its strategic status, to turn it into just another commodity, we need to break this monopoly. We need to open the fuel market to fuel competition. We shall return to this subject.
Cartels.
Let’s hold that thought for a moment and get back to the second part of the picture, which is that this mo-nopoly is married to a cartel. The OPEC oil cartel sits on 78 percent of world oil reserves and, like any cartel, the entire purpose of its being is to maximize revenue for its member regimes. By the very nature of its exis-tence, that’s what it does.
In the early 1980s, OPEC produced about 26 million barrels of oil a day. Think of what the global economy has done over the last 3 decades. Oil consumption has grown drastically. Non-OPEC production has grown drastically. You know how much OPEC produces to-day? Just about the same: 26.8 million barrels.
This cartel has a strategy of deliberately constrain-ing supply to drive prices up. That’s what cartels do.
In that context, since our foil in this game is a cartel, we need to think about some of the primary policies discussed when it comes to dealing with it.
On the right, it’s generally, “Drill, baby, drill.” Ex-pand supply. On the left, it’s generally. “Americans are consuming too much, we need to drive cars that are smaller.” Among the pundit class, you may get calls for gas taxes and so forth. So we have advocates for efficiency and conservation on one side, expansion of supply on the other.
Let’s remember our foil is a cartel, and let’s see how the cartel deals with these policies. We have a historical event that can serve as a simulation: the oil price spike of 2008. In that year, oil prices spiked to
$147 a barrel. Gasoline prices at the pump went up.
Consumers are rational economic creatures. In the United States, people responded by driving less. Our gasoline consumption dropped by 10 percent. Oil
con-sumption dropped by a million barrels a day. A simi-lar phenomenon occurred elsewhere—people drove less, and consumption dropped.
What did the cartel do in response? They pumped less. They met several times over the course of 6 months. They cut production by 4 million barrels a day—actually they cheated, so in effect they cut pro-duction by 3 million barrels a day. But, in essence, we used less, they pumped less.
Why does this event simulate how cartels might respond to efforts to break their monopoly? You can think of that oil price spike as a proxy for a number of different policies. You can think of it as a proxy for a massive gas tax increase. It’s not a gas tax that was paid to Uncle Sam, however. It was paid to Uncle Saud or one of his brethren, but it was a gas tax.
So we know how OPEC will respond when the demand is adjusted in that way. We can think of the 10 percent reduction in gasoline demand as a proxy, not an exact proxy, but a proxy for an increase in ve-hicle fuel efficiency. It is not an exact proxy inasmuch as vehicle fuel efficiency would be longer lasting, but is a proxy in the sense that it is a similar concept. What does OPEC do in response to this sort of static demand reduction? They pump less.
We also know how OPEC will respond when faced by expanding supply. We have to understand that pumping more and using less are essentially two sides of the same coin from the perspective of the car-tel. What happens when we expand non-OPEC pro-duction of oil? Use tar sands, or anything else? How would the cartel react? It pumps less.
If you look at the last several decades, you’ll see that this is a nonlinear relationship because we need to factor in the rise of the developing world, but the
relationship is there. So, we use less. They pump less.
We drill more. They pump less.
As long as you’re playing in the oil field, you can-not manipulate the cartel. As long as your strategies are static strategies and you are relying on static de-mand reduction or static supply increase, your poli-cies are predictable. The cartel knows how to respond.
It might take it some time to erode inventories in the market, but the cartel knows how to respond.
Breaking the Monopoly.
We need to break out of this paradigm by putting other commodities into competition with oil on the ve-hicle platform. Now, how do we do that? How do we, for instance, monetize the price difference between oil and natural gas today when it comes to transporta-tion? How do we monetize the price difference be-tween oil and coal when it comes to transportation?
Vehicles must be platforms that enable fuel com-petition. So let’s talk about options in the near, mid, and long term. In the near term, the easiest thing to do is go to an open fuel standard that essentially ensures that new cars are platforms for liquid fuel competition.
The vehicles should be able to run on gasoline or a variety of alcohol fuels. This capability costs less than
$100 a car. You’re essentially talking about download-ing a different piece of software to a control chip on the car and making the car essentially corrosion resis-tant. You’ll need, in other words, higher grade fittings, because alcohol is more corrosive than gasoline.
What does that do? Let’s talk about some of the alcohols that you have out there. Ethanol is one, but methanol is more interesting, specifically because of the natural gas question.2
When you ask yourself how you monetize the price difference between oil and natural gas when it comes to transportation, you must ask yourself what people would do if cars were open to liquid fuel competition.
They would do just as people did in Brazil in 2008. At that time, 90 percent of new cars in Brazil were flex-fuel vehicles. New cars in Brazil went from zero to 70 percent flex fuel in only 3 years, and they are made by the same automakers who sell cars in the United States. In 2008 when oil prices spiked, consumers in Brazil went to the pump. They compared the per-mile cost of different fuels, saw that unsubsidized alcohol was cheaper than oil and bought it. That year, gasoline became an alternative fuel in Brazil. Brazilians used more alcohol, i.e., ethanol, than they did gasoline.
Ethanol in Brazil is made from sugar cane. We have tariff issues which we can talk about later. They are worth discussing, especially given the need to develop a healthy interdependence with countries in Latin America. Our influence there has been steadily eroding. There are not many tools that we can use to strengthen our relationships. Opening our markets to them is a very good one.
The important thing is that when you have a choice, you compare the economic alternatives and choose what makes most sense from an economic per-spective. Let’s look at a vehicle that is open to using gasoline and a variety of alcohols. Let’s look specifi-cally at methanol, an alcohol that can be made from natural gas and coal, and think about the economics of it. Methanol’s spot price today is around $1 per gal-lon. Methanol has about half the energy of gasoline.
So you would pay around $2.50 for the same amount of methanol that you would need to drive as far as you would on a gallon of gasoline. That’s including retail
markup and everything else. That means that if you could use it in your car, you would buy it unless you don’t care about price and don’t want to have to refuel twice as often. A lot of people would buy it.
That’s what an open, competitive market looks like. The issue is the same if the fuel is made from coal, sugar cane, cellulosic biomass, corn, or anything else. You compare the per-mile economics and decide whether or not it makes sense for you to buy it. If it does, you will buy it.
What does that do to the cartel? We have a bizarre situation today in which a cartel that is full of bad ac-tors and that plays a hugely negative influence on the world stage, controls much of the world’s oil reserves.
We don’t even need to look at the Middle East. We can just talk about Venezuela in Latin America. In OPEC, you have a cartel that controls most of the world’s oil reserves, despite accounting for less than a third of global oil production. It is the modulator of the oil market. But if you have an open and competitive fuel market, there will be a lot of energy commodities play-ing in that market. There won’t be a cartel or a group of countries controlling all of those energy commodi-ties. Also, there won’t be one single crisis point that brings all of those commodities down, that disrupts all of those commodities. There will be all sorts of dif-ferent types of crisis points. Each one could bring a given resource down. But you’d have to have a bizarre series of catastrophic failures to bring our transporta-tion sector to a screeching halt.
This is something we should think about since there would be no such thing as a global economy without transportation. That’s why oil is so strategic, because it underlies the very fabric of our global economy, of our lives.
Thus liquid fuel choice is step one. Liquid fuel choice is extremely important. As we look toward the future, electrifying transportation is also extremely important. Why? Because on a per-mile basis, electric-ity is much less expensive than oil. Again, look at the cartel and remember that one strategy it has used pe-riodically is to flush a lot of oil into the market. It does this when it gets concerned that countries are actually going to get somewhat serious about breaking free from its hold. Well, to undercut electricity, they would have to drop the price of oil down to $5 or $10 a barrel.
This is not easy to do when you have huge demograph-ic pressures to contend with. Look at the Middle East and North Africa. We’re dealing here with sclerotic, corrupt regimes across the board. Many of them, in order to survive, have made a cradle-to-grave bargain with their populations: “We’ll supply what you need, just don’t storm our palaces.” That bargain doesn’t al-ways hold, as we have seen, but there’s a reason why the Saudis increase entitlement spending whenever instability occurs. It isn’t because their princes all of a sudden decided out of the goodness of their heart to distribute more money to the population. It is because they want to keep their heads attached to their necks.
In sum, you can’t undercut electricity by manipu-lating oil price. This means that having electricity in the transportation fuel market will in essence serve to protect the other liquid fuels. That’s because whether you look at methanol from natural gas, methanol from coal, ethanol from sugar cane, or even ethanol from corn—and that’s with no subsidies, no tariffs — all of them are economic at $50.00-$55.00 a barrel of oil.
You are probably asking yourself how come we’re not using these fuels if they are economic. I’ll present a very simple analogy to you. Let’s say you are lactose
intolerant, but you want to start each day with a cup of coffee with some milk in it. If the price of rice milk and soy milk goes to an unaffordable $50.00 a gallon, you still can’t put cow milk in your coffee. Essentially, therefore, the cars we are manufacturing today are al-lergic to anything but one type of fuel. It doesn’t mat-ter how economic the other fuels get in comparison to oil, we can’t put them in our car today because the engines will not accept the fuel.
Does that makes sense? That’s the issue. You can’t say that the free market will settle this when we know from economic theory that the market has a very hard time dealing with monopolies and cartels. In effect, by closing its vehicles to fuel competition, the auto indus-try is colluding with the cartel. It doesn’t do this by design, or because it wants to. Nor does it do so be-cause it is engaged in some kind of bizarre conspiracy.
It does it out of inertia or habit, call it what you will.
But that is what is happening.
During the Q-and-A, we’ll talk about that third el-ephant in the room, the developing world. The major thing to keep in mind about electrification of the trans-portation system is that it will be a very long time be-fore it happens. It will be decades bebe-fore we get mass market penetration. We must not look at it as a silver bullet and neglect everything else.
An integrated strategy, including a fully competi-tive fuel market: that’s how we’ll break the power of the cartel. That’s how we’ll reduce the nefarious influ-ence of all of these oil-rich bad actors on the world stage and reduce their ability to destabilize various regions of the world. It’s the only way that we can en-sure our continued prosperity and economic growth.
It’s not a sufficient condition for avoiding national decline but it’s certainly a necessary one.
PROTECTING THE PRIZE