How Oil Can Improve Our Long Term Energy Situation

Energy Security Trust

Energy policy is a major topic of discussion during almost every State of the Union address. The most recent address was no exception, with President Obama devoting a substantial portion of his speech toward reviewing recent energy accomplishments, and then promoting new energy initiatives.

One of those initiatives was one of the three major energy policy recommendations that I promoted in my book Power Plays. Here was President Obama’s version during the State of the Union address:

I propose we use some of our oil and gas revenues to fund an Energy Security Trust that will drive new research and technology to shift our cars and trucks off oil for good. If a nonpartisan coalition of CEOs and retired generals and admirals can get behind this idea, then so can we. Let’s take their advice and free our families and businesses from the painful spikes in gas prices we’ve put up with for far too long. I’m also issuing a new goal for America: Let’s cut in half the energy wasted by our homes and businesses over the next 20 years.

In my book, I made three policy recommendations that I believe would not only enhance the long-term energy security of any country, but are also capable of receiving broad political support. The recommendations address the demand side, the supply side, and they minimize the risks if supply and demand projections are grossly in error. The three policy recommendations are:

Shift some income taxes to fossil fuel taxes in a revenue neutral manner
Use the proceeds of oil to reduce dependence upon oil
Support the Open Fuel Standard

The second proposal above is the one that the President endorsed during the State of the Union address. As I explained in my book, I am concerned about the impact of continued reliance on fossil fuels. But I have no doubt that we will still need stable oil supplies for a number of years as we transition away from oil. The proposal is designed to meet those petroleum needs during this transition phase, while using some of the proceeds to hasten the transition. In short, my proposal was that governments encourage domestic drilling — to meet our energy needs in the short-term — while using the royalties and tax revenues to fund programs that reduce dependence on oil.

Environmentalists vs. Drill, Baby, Drill!

But environmentalists are generally opposed to opening up areas to additional drilling. They think there simply isn’t a need to do so, and that it will just delay a transition to alternatives. They see oil companies and not ordinary citizens as the primary beneficiaries of oil drilling.

Many environmentalists believe that if they can prevent further development of oil reserves, then alternative energy, public transit, and conservation will necessarily rise to the challenge and alleviate the dependence on diminishing fossil fuel reserves. But the risk in this approach is whether the alternatives can be delivered when they are needed, and whether they can cover severe shortfalls. What if they can’t? What is Plan B? Shortages? Rationing?

On the other side are people who believe that underneath U.S. territory lies an ocean of oil, waiting to be tapped — if environmentalists would only get out of the way. They believe that energy independence is within our grasp if we aggressively develop our natural resources. But this notion suffers from a very similar risk as the position of environmentalists: What if the oil that is available simply can’t cover any severe shortfalls? What if the expectations that these vast oceans of oil exist lead us to delay actions on alternatives? Again, what is Plan B? Military action? A continued transfer of wealth to OPEC?

The majority of us fall somewhere in between these two positions; we want to see some domestic development as well as development of alternatives. This proposal would enable one to fund the other, while giving both environmentalists and drilling advocates something they want. But each side would need to compromise a bit.

Something We Can All Agree On

Both opponents and proponents of drilling would likely agree that our dependence on petroleum—and, specifically, imported petroleum—comes with risks.

Among the arguments from both sides are that this dependence puts our national security at risk and that it poses risks to the environment. I think both sides would agree that a long-term solution to petroleum dependence could be a combination of conservation along with alternative options such as higher-efficiency vehicles, electric transport, and public transit.

Where large numbers will start to disagree is whether this is achievable in the short term, or whether it is going to take a few more technological developments and more than a decade to see most of our petroleum dependence displaced.

I fall into the latter category, for a variety of reasons. I am familiar with most of the alternatives, and they are simply not competitive even at gasoline prices of $4 or $5/gallon—nor are they scalable. To illustrate that point, consider Europe, where gasoline prices in many locations are double the price in the U.S. Even at these prices, petroleum remains the dominant choice for transportation in Europe (albeit at lower levels of consumption than in the U.S.). But it is going to take more than price, — or, at a minimum, much higher prices than Americans probably anticipate — to move us away from a high level of dependence on petroleum.

Conclusion: Using Oil to Get Off of Oil

So I propose a compromise where we open up some of the more promising areas to exploration, and then earmark some or all of the royalties to funding fossil fuel alternatives. Leases on federal lands should also be structured so that governments share in any windfall if oil prices skyrocket. One of the problems with windfall profits taxes is that they discourage investment in projects with marginal economics. But oil companies don’t plan projects with an expectation of $200/barrel oil. A lease that is structured to give governments an increasing portion of revenues at much higher oil prices will be unlikely to impact project economics for an oil company because the possibility of such high prices will be heavily discounted.

With the revenues, we could fund expansion of public transportation. We could provide a tax credit of $1,000 for each person who purchases a car that gets over 45 mpg. We could use these oil revenues to fund wind and solar power, freeing up natural gas that could then be used to displace petroleum in compressed natural gas (CNG) vehicles.

This should be a compromise with attractive elements for both sides. If we don’t agree to such a compromise, then what’s going to happen is that as prices continue to rise, so will the pressure to drill, and governments will eventually cave in to this pressure. But by failing to earmark the money for alternatives, it will just postpone the inevitable day of reckoning for oil supplies.

So, I endorse this suggestion from the President, as long as it is structured in the right way. It can’t be simply a new tax on oil companies that funnels money into alternatives, because that approach will have unintended consequences. By structuring it in the way I have suggested here, it has a good chance of 1). Gaining broad political support, and 2). Achieving the desired goals.