First Principles June 2006

Shock Absorption

For America, energy security lies closer than you might think

It should be reassuring that the “energy crisis” one often reads about is always “looming.” In recent months the price of oil has been persistently higher than $50 a barrel. Just a few years ago, when it fell to less than $10, a price that high would have seemed both improbable and quite scary. It would have evoked memories of the oil shocks of the 1970s and the ruinous economic dislocation that followed. But in 2006, preoccupied as the country may be with its oil addiction and energy security, we still aren’t in a crisis, apparently. The crisis is only looming.

Looking at the performance of the economy, you could be forgiven for failing to notice the price of oil altogether. Growth is strong; unemployment is low; inflation is under control. Energy shocks do not look like this. Oil at $50, $60, $70 a barrel? People resent the price of gas at the pumps, yes. But the economy seems to glide on, impervious.

Of course, high oil prices have acted as a brake on an otherwise strong economy—but only a modest brake. The biggest reason is that the economy uses energy, and especially oil, much less intensively than it did before. Since 1970 the country’s economy has grown by roughly 200 percent; its consumption of oil has risen by just 40 percent. The economy still needs oil to function. And in absolute terms, it needs more than before. But it needs far less in relation to output; that is, oil is a smaller component in the goods and services that America produces than it used to be. This makes a huge difference. Why? Because any given rise in oil’s price becomes easier for the country to absorb.

That is the real meaning of “energy security.” Contrary to what many politicians appear to believe, energy security does not reside in a low and stable price of oil. Oil prices have always fluctuated wildly and probably always will; the structure of the industry makes price stability an unrealistic goal. Security lies in the improving ability of the economy to take widely fluctuating prices in its stride. The economy’s movement away from energy-intensive industries toward services has had precisely this effect. So too has the ordinary use of new, energy-saving technologies designed primarily to drive down costs. To some extent, energy efficiency and energy security turn out to be the same thing.

Much of the rhetoric about oil today is overheated. The world is not running out of the stuff, or out of energy more generally. With present technologies, proven and probable reserves of oil will be sufficient for decades. Even if prices somewhat lower than those already seen this year were sustained, an array of existing but not yet widely applied technologies would make it economically feasible to extract oil from tar sands or shale, or to convert coal to liquid fuel. There will be enough fuel from those sources to meet the world’s needs as far into the future as one cares to look—even if no brand-new energy-producing technologies emerge anytime soon.

The biggest immediate problem is not the supply of energy in the long term, but its fixity in the short term. Bringing new supplies onstream takes time, whether it is a matter of building new power plants, sinking new oil wells, or adding new refining capacity. At the same time, demand for energy is insensitive to price; when capacity is stretched it takes a very sharp increase in prices to push consumption down. Today, new investments are going ahead and consumers appear to be reining back. Once capacity comfortably exceeds demand again, as it did through the 1980s and 1990s, prices may eventually fall just as sharply. But the cycle will likely repeat, leading to periodic vulnerability to oil shocks. The unremarked improvement in America’s energy security has been impressive, but it needs to continue, and it should be happening faster than it is.

Up to a point, there is a public interest in protecting the economy from wasteful volatility by speeding the rate of decline in oil’s systemic importance—by, as it were, investing in more shock protection than ordinary private cost saving will achieve. Environmental risks clinch the argument. The science and economics of manmade global warming are far more complicated than most commentary on the subject would have you believe, but there is a strong case for curbing global greenhouse-gas emissions. This can be done economically, provided the investments are phased in over an extended span of time. (For instance, it is far cheaper to build a new plant that emits less carbon dioxide than to retrofit an existing plant to the same effect. One failing of the Kyoto Protocol is its rush to impose immediate, drastic changes at ruinous cost.) Still, the planning and the policies need to be put in place now.

Energy diversification would better insulate the economy from oil-price shocks and reduce emissions of greenhouse gases. The economic instruments needed to speed this diversification away from oil are close at hand: taxes on greenhouse-gas emissions (in principle, a tax on carbon, implemented through higher taxes on gasoline and other fuels) and subsidies for the use of oil-saving technologies.

The current administration has repeatedly paid lip service to the idea of energy diversification but has done little so far to put it into practice. It should do much more. Not because the oil is running out, and not because the world has just a few years to avoid a global-warming catastrophe: there is plenty of oil, and dealing with global warming intelligently must be a multidecade undertaking. Rather, such policies are an opportunity for the United States to lead other nations in effectively addressing the world’s biggest environmental risk, and become more prosperous in the bargain.

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Clive Crook is a senior editor of The Atlantic.

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