The Energy-Security Paradox

The United States produces more oil and uses less, but prices are still high. What is to be done?

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America is facing an energy-security paradox. Our domestic oil production is on the rise; the cars that roll onto our roads are more efficient than ever, and net oil imports are at their lowest level since the days when President George Herbert Walker Bush lived in the White House. Yet none of this has reined in the price of gasoline. This runs counter to U.S. conventional wisdom over the past forty years, touted by every president since Richard Nixon. The conventional wisdom had it that, if we just lessened our oil imports by drilling more domestic oil and by learning how to use less, we would pay less at the pump. We have done both and we are paying more. Something is wrong with our method.

The reason both domestic drilling and increased fuel efficiency have not reduced the global price of oil, and hence gasoline prices (the cost of crude accounts for about two-thirds the price of gasoline) is that global conventional-oil reserves are dominated by a cartel, OPEC, which comprises nations that are heavily dependent on oil revenues for their economic well being. When the price of oil goes below a certain level those countries cannot meet their budgetary requirements and are forced to accumulate debt or cut entitlement spending at the risk of social discontent. Following the so-called Arab Spring, those budgetary needs have risen sharply as rulers of the Gulf monarchies effectively bought stability from their citizens with salary raises, subsidies and other perks – all paid for by oil revenues.

Consider the case of Saudi Arabia, OPEC’s largest producer and holder of a quarter of the world’s crude oil reserves. The 28 million Saudis, 40 percent of whom are under the age of fifteen, do not pay income tax, yet they expect the House of Saud to fund cradle-to-grave services and heavily subsidized food and fuel products. Most Saudis work for the bloated public sector, where salaries are two to three times higher than in the private sector. To keep its system intact the Saudi government must generate ever greater income from oil sales.

But the Kingdom now is nearing peak production. Today, Saudi Arabia produces roughly 10 million barrels per day with production capacity of 12.5 million barrels per day. Sadad al-Husseini, former head of exploration of Saudi Aramco, concedes that Aramco’s current production level cannot be sustained. To make things worse, Saudi Arabia is the world’s sixth—yes, sixth—largest oil-consuming country, gobbling more crude than major industrialized countries such as Germany, South Korea and Canada. At its current consumption growth rate, Saudi Arabia will surpass Russia and India by the end of the decade. With so much of its oil consumed at home, the Saudis have fewer barrels to export even as their government expenditures are on the rise. This means that there is only one way for them to make ends meet: keep prices high by adjusting the production of oil downward in order to offset any growth in supply emanating from the United States. In other words, when we drill more, they drill less.

Saudi Arabia’s story is more or less the story of the other eleven members of OPEC. The cartel’s modus operandi has been to throttle down supply to drive prices back up while adjusting the definition of a “fair” price. In 2004, OPEC’s “fair” price was $25 a barrel. Two years later, $50 was considered “ideal.” Now the fair price is $100. With the onset of the American oil boomlet, the organization is sure to go down the same path. In fact it already has reined in its supply continuously for six months and is currently producing 30 million b/d, the exact number of barrels it produced forty years ago. Over the past four decades the world GDP grew fourteen-fold; the number of cars quadrupled; global crude consumption doubled. Yet OPEC, which sits on top of three quarters of the world’s conventional crude reserves, has kept its contribution to the oil market the same. Realistically, we cannot defeat the cartel in the courts or with diplomacy. What we can do is deploy what it fears most: competition with our cheap and abundant natural gas.

By opening vehicles to a variety of natural gas-derived fuels, we will be able to pit a cheap and abundant commodity against one whose price is inflated and controlled by a cartel. This is true for compressed natural gas; electricity, which can power pure electric vehicles and plug-in hybrid electric vehicles; or methanol, a liquid fuel sold today for a dollar less than gasoline on an energy-equivalency basis that can power flexible-fuel vehicles that cost manufacturers an extra $100 to make compared to gas-only cars.

The International Energy Agency predicts that by the end of the decade the United States will overtake Saudi Arabia as the biggest oil producer. This may happen, and there are many reasons to welcome the development. But we should not delude ourselves into thinking that the role of driller-in-chief will bring lower crude prices. It won’t. Unless we break oil’s virtual monopoly over transportation fuel it will be the disgruntled youth in Riyadh who will determine how much we pay at the pump.

Gal Luft is senior adviser to the United States Energy Security Council and co-author of Petropoly: The Collapse of America's Energy Security Paradigm.