Thursday, April 12, 2012

Ticket to Ride

Energy, what is the problem and what is the solution?

The economic problem with energy consumption today is quite singular and clear: high gas prices.  These higher gas prices are akin to a tax on every American and drain from our pool of resources to spend, save and invest.  Higher gas prices are driven by higher oil prices.  

Why focus on petroleum prices and not other energy sources?

Because only petroleum is really going up in price over the long term, and is anywhere from 3 to 5x the price of Natural Gas or Coal (and this relationship is getting worse not better since 2010).  Further, U.S. Oil production peaked in 1970 and has been long in decline while the others have seen upsides in domestic supply reducing likelihood of further cost pressures.

Source: U.S. Energy Information Administration / Annual Energy Review 2010

Where is petroleum used?

Below is an excellent (and busy) chart showing how our energy is consumed in the U.S.  Instead of going blind, I will just tell you the conclusion.  26% of ALL energy consumption is petroleum used for transportation.  Three quarters of petroleum is used for transportation, and virtually all transportation activity runs on petroleum. 

Source: U.S. Energy Information Administration / Annual Energy Review 2010

Where does our Petroleum get produced?

As you can see from the chart below, we produce about half of the petroleum we consume, and we import the other half.  Of the piece we import, we get a little less than half from OPEC countries and a little more than half from non-OPEC countries like Canada and Mexico.

Source: U.S. Energy Information Administration / Annual Energy Review 2010

What drives the price of Petroleum?

The cause of higher petroleum prices can be debated, but generally part of the discussion in no particular order: weak dollar, contract speculation, Middle East relations, global demand, increased environmental constraints, and reductions in federal drilling permits.  I do not intend to argue the each of the causes, just recognize that most have at least some merit and acknowledge that reducing oil prices is the issue we most desperately need to fix.  Further, we should latch on to concepts where we have the most control and can make a significant impact.

So, how do we control Petroleum Prices?

First, we should throw out factors unrelated to direct supply and demand that play a role in the price.  The weak dollar and Middle East relationship may impact our oil prices, but since they are used to battle things like unemployment and nuclear weapons, they have to be resolved in the context of other problems so I will set them aside.

In order to increase supply we need to quite simply drill more, which is impacted by allowing more drilling on federal lands and offshore.  Further, we need to increase supply from friendly nations like Canada (cough, Keystone Pipeline, cough).  This shifts our reliance from OPEC generated oil and reduces their pricing power on the world market.  While I think these supply improvements should absolutely be pursued, we have a very heavy resistance from the environmental wing and the President to do so.  On the whole, I believe we do get a strong net benefit from pursuing these things, but the impact to overall domestic energy supply and thus price is less clear.

The more intriguing solution likely comes from reducing the demand for petroleum.  Remember, petroleum's main purpose is for transportation.  You cannot convert power plants, heating systems, industrial power, etc away from petroleum because they are already there.  YOU MUST CONVERT CARS AND TRUCKS AWAY FROM PETROLEUM TO CHANGE OIL DEMAND.  How?  Basically, we have 2 options:

1) Convert cars and trucks to electric with batteries and plug them into the wall.  I am 100% for this!!  With one major exception, we do NOT yet have an economic battery powered solution.  So should we just wait until someone develops it and continue to give our left arm at the pump? No.

2) Convert cars and more specifically commercial trucks to Natural Gas.  Thanks to the shale gas revolution brought about by "fracking" technology, we are seeing a boom in natural gas production that will increase our supply by 25% over the next 20 years (below).  By moving at least partially to natural gas powered transportation for which technology already exists, we can have very significant impact on oil demand.