Breaking the tyranny of oil

Contrary to popular belief, high gasoline prices are good, and they are good precisely because high oil prices are very bad. I’ll admit that doesn’t sound right, but allow me to explain. I’ll start with oil. Saudi Arabia, the country able to produce oil at the lowest cost, decided in 1986 to gain market share by increasing production. That caused the price of oil to collapse, and despite a momentary increase during the first Gulf War, oil prices remained low for the next 15 years. It’s no coincidence that that period of cheap oil witnessed the rise of democracy in Eastern Europe and the former Soviet republics, as well as a particularly long and prosperous economic expansion in the United States. At its nadir in 1998, oil cost just above $10 per barrel, and The Economist argued that the world faced a crisis of too much oil.

What a difference a decade makes. In real terms, a barrel of oil now costs 11 times more than it cost just 10 years ago, and political reforms in oil-exporting countries such as Russia, Venezuela, and Iran have suffered severely as a result. To wit, here are two New York Times headlines from June 3: “It Isn’t Magic: Putin Opponents Are Made to Vanish From TV” and “Chavez Decree Tightens Hold on Intelligence.”

Breaking the tyranny of oil will require a market-driven movement toward electrification of the transportation sector. We can’t run individual cars on wind, coal, or nuclear fission, but we can deliver electricity generated from them to cars with rechargeable batteries.”

In 2007, Russia exported more than 5 million barrels of oil daily, while Venezuela exported some 2.2 million barrels. At current oil prices, those exports are worth nearly $240 billion and $108 billion–a significant portion of each country’s gross domestic product (GDP), about $2 trillion and $334 billion in 2007, respectively. This is probably why Venezuelan President Hugo Chavez kicked Exxon out of Venezuela last year. Exxon is extremely efficient at producing, transporting, and selling oil, but who needs experts when–at these astronomical prices–any fool can make a nice profit from Venezuela’s prodigious fields? Likewise, it seems as though every week, Russia decides to “renegotiate” its terms with British Petroleum.

Oil-exporting countries become less free and democratic as oil prices rise, and their leaders are enabled to enrich themselves without investing in their people. For many years, the Heritage Foundation has compiled an index of economic freedom. This year’s report concluded that the Americas enjoyed the greatest economic freedom, followed by Europe, Asia and the Pacific, southern Africa, and finally, the Middle East. The report speculated that the Mideast’s stunted economic growth was due to its overreliance on oil wealth. Their analysis showed that the five Middle Eastern countries that export the least oil (worth less than 10 percent of GDP) “have 10 percentage points more economic freedom, using a population-weighted average. They also have lower inflation and slightly better employment and income levels, although their growth rates have been insignificantly lower.”

The report goes on to describe an economic theory known as “Dutch Disease”: “[It] holds that natural resource wealth can inhibit the development of other sectors by skewing wages. In contrast, resource-poor countries must give their citizens a certain amount of economic freedom in order to create a living for themselves, developing human capital in order to create value. . . . In most Gulf states, even the process of extracting the oil is in the hands of foreigners. It requires no investment in labor, no investment in humans, and only a marginal amount of investment in the land. People need different freedoms to be productive, but oil does not generate the incentives needed for societies to create those freedoms.”

Indeed, I challenge anyone to name a democratic, oil-exporting country that established democracy after their oil was discovered. (Canada and Norway are both democracies and oil-exporting countries, but their democracies substantially predate the discovery of their oil.)

In addition to enabling dictators and retarding democratic reforms, the astronomical price of oil is wreaking havoc with the U.S. current-account deficit. Our trade deficit was about $60 billion in May–that month, we imported around 400 million barrels of oil. At the median price of $130 per barrel, our oil-import tab was nearly $53 billion. The gaping size of our current-account deficit is partially responsible for the pitiful value of the U.S. dollar.

We’re financing that deficit by borrowing money from foreign governments and selling U.S. assets. As investment tycoon Warren Buffet likes to say, we’re essentially holding a giant garage sale and more than 80 percent of the money we earn from selling our furniture, we spend on oil. Indeed, we’re oil addicts. As long as oil prices stay high and we continue to fill up our SUVs, the dictators of oil-exporting countries will have no impetus to liberalize their economies or empower their people. Every time you see the dial on the gasoline pump roll past $50, $60, $70, then you should picture all those dollars drifting across the ocean into the hands of Russian Prime Minister Vladimir Putin, Chavez, Iranian President Mahmoud Ahmadinejad, and the like. Make no mistake about it, very high oil prices are very bad.

That brings us to high gasoline prices. It shouldn’t surprise anyone that $4-per-gallon gasoline is a hot political issue–voters react viscerally to increasing gasoline prices. In response, presumptive Republican presidential candidate John McCain has called for a temporary repeal of the federal gasoline tax and an end to the moratorium on offshore oil drilling. If gasoline prices remain high, we can count on myriad similar policy proposals to moderate the price. And what a shame those proposals will be, because current gasoline prices present us with a tremendous opportunity to start changing the game for good.

Breaking the tyranny of oil will require a broad-based, market-driven movement toward electrification of the transportation sector where currently, oil has a monopoly. We can’t run individual cars on wind, sunlight, coal, or nuclear fission, but we can generate electricity from them and deliver that electricity to cars with rechargeable batteries. With electrified transport, drivers will always be buying the cheapest available source of energy through their utility company. At current oil prices, gasoline costs nearly $30 per gigajoule (a unit of measure for energy supplied), while electricity delivered to homes costs $30-$60 per gigajoule. The key, however, is that electric motors can convert about 85 percent of that electrical energy into a car’s mechanical energy, while gasoline engines can only convert about 30 percent of the chemical energy in gasoline into mechanical energy. So at today’s gasoline prices, electricity is an attractive option.

Entrepreneurs, investors, scientists, and major corporations are all working feverishly to develop the plug-in gasoline-electric hybrid cars that will bridge the divide between today’s petroleum-based transportation and tomorrow’s everything-based transportation. The key to a viable fleet of plug-ins is the battery’s energy and power density, which determine how far a vehicle can get on battery power alone. If that range were to approach 40 miles, then most driving would be decoupled from petroleum.

General Motors has made a serious commitment to deliver a plug-in with such a range called the Volt, while companies such as A123 Systems are in a race to deliver the necessary batteries. I’m confident that they’ll deliver, but will the market be there when they do?

At current gasoline prices, people will flock to plug-ins and the oil monopoly will begin to crumble. But if gasoline prices fall back to $2 per gallon, it’s not clear what consumers will do. In the 1990s, when oil and gasoline were cheap, Americans bought SUVs in astonishing numbers. That inefficient automobile fleet has come back to bite us hard. By buying those SUVs, we primed the pump (so to speak) for the current wealth transfer from oil-consuming countries to oil-exporting countries.

But coupled with high gasoline prices, that inefficiency is also affecting our behavior–perhaps enough to usher in a new age of electrified transport. For this reason, policy makers should seize the opportunity to make certain that gasoline prices never drop below $3.50 per gallon. To make that happen, we need a federally mandated “floor” on gasoline prices. The law would be simple: Whenever the price of gasoline dropped below $3.50 per gallon, federal taxes would kick in to keep the price above $3.50. It would be a regressive tax, but the additional revenue could be used to offset an increase in the standard exemption for federal income tax, thereby progressively decreasing everybody’s income tax liability.

As the Heritage Foundation report makes clear, freedom is inversely related to oil wealth, and that’s partly because oil has enjoyed a 100-year monopoly on transportation. The technology to move away from petroleum-based transport is coming, but we can ensure it does by keeping the cost of gasoline relatively high through a creative use of the tax code.

Would you rather send young men and women to war for oil, or consistently pay at least $3.50 per gallon for gasoline? Accepting a tax-based “floor” on gasoline prices should be considered a patriotic duty, and it’s the only way we will ever break the oil tyranny.