Energy

The Third Oil Shock; Notes on Climate Change

The Third Oil Shock and the Dollar

Oil prices have jumped so high so fast, that we are arguably in the midst of the Third Oil Shock. But why is oil rising? Part of the answer is demand from India and China. But there's more to the story. It's not often that I find myself in agreement with the editorial page of the Wall Street Journal, but David King, a former Fed economist, makes an important point in an oped today, echoed in an editorial, that a large share of the current run-up in oil prices as well as prices of all commodities is due simply to the decline of the dollar.

According to King, in Euro terms, oil is up but far less than in dollar terms. Had the greenback not undergone its steep drop since 2002, oil would be selling for about $75 today instead of $135. The good news here is that managing the exchange rate--though not easy--is something the Treasury in concert with the Fed does every day. The bad news, of course, is that the dollar has not collapsed by accident. Arguably, it has long been overvalued and its high value allowed Americans to stock up on massive amounts of cheap goods from abroad--for which we incurred a trillion dollar debt, now held by the Bank of China in the form of US bonds--and also killed US exports.

The decline of the dollar in Euro terms but in Yuan terms as well (about 20% as opposed to 60%) will eventually lift US exports. But that will take time. In the meantime, we are importing inflation.

Finally, since so many countries peg their currencies to the dollar, the next shoe to drop in the surge of oil prices may be an inability of some developing countries to pay their oil bill as happend after the second oil shock, triggering the 1980s international banking crisis.

A Magic Bullet for Climate Change?

On a separate topic, climate change, Freeman Dyson asks an interesting question in the current New York Review of Books. Could there be a silver bullet to solve the climate change problem? In reviewing a new book by William Nordhaus, Dyson points out that CO2 levels vary seasonably by about 8%, with plants absorbing about 8% of the globe's CO2 every growing season and then disgorging it come winter. He hypothesizes that genetically engineered super trees could, in the future, be programmed to pull a lot more carbon out of the atmosphere. To do so, however, a great deal of science and technology development must happen first. That's why allocating money to R&D is likely to be such an important part of a climate change solution.

Senate to Debate Cap and Trade

In advance of consideration by the Senate of the Lieberman Warner bill to create a cap and trade system to combat climate change, currently scheduled for the first week in June, stakeholders are already beginning to float arguments. Legislation foes such as the Heritage Foundation are talking about the potential damage to the economy of higher energy prices that may result from putting a price on carbon--detailing the impact state by state. What they don't mention is that credits if auctioned off will provide revenues that offset higher prices. Nontheless, for climate change legislaton to move forward next year of not this year, these arguments are a necessary part of the process of calling out stakeholders. Before the legislation can pass, it's important to find out where the opposition lies and what the obstacles are in order to address them. Stay tuned.

Your Flight Has Been Cancelled

"The airline industry as it is constituted today was not built to withstand oil prices at $125 a barrel, and certainly not when record fuel prices are coupled with a weak US economy". So said American Airlines CEO Gerard Aprey yesterday in announcing dramatic cuts to service that will eliminate thousands of jobs, remove one of 8 American planes from the sky and charge passengers $15 to check a single suitcase.

Arpey warned the rest of the industry to follow suit or plunge into bankruptcy. And today, the Wall Street Journal reports that the International Energy Agency is anticipating reductions in supply that may drive prices higher.

The wholesale scaleback of air service as we know it is just one of the many ways skyrocketing fuel prices are beginning to alter America's way of life Yet shockingly, we still have no plan or policy to deal with it. President Bush begging Saudi King Abdullah to raise production last week or even Congress ending purchases for the Strategic Petroleum Reserve is not a policy.

While Senators Obama and Clinton have proposed broad energy policies, action is needed now. Conditions in the airline industry are approaching those after Sepember 11th when the Strategic Petroleum Reserve was tapped and energy officials should consider that now. Congress should move immediately to fund the Production Tax Credit and Investment Tax Credit to fund wind and solar investments. And the White House should convene a national energy council, as proposed by both Democratic Senators, modeled after the National Security Counsil, to meet weekly to address the current crisis and long term issues surrounding energy prices, dependence on foreign oil and climate change. Things will get worse before they get better, but at a minimum a crisis such as this needs attention.

US Oil Dependence Predicted to Decline

Markets work. And so does policy. That's the optimistic message from Guy Caruso, head of the Department of Energy's statistical arm, the US Energy Information Administration who told the Financial Times that US dependence on foreign oil after rising for 30 years will drop from 60% to 50% in the next seven years. Caruso estimates that US imports will fall through 2030 thanks to lower consumption as prices rise and as biofuel mandates tighten. Caruso's prediction is likely to reduce calls to drill in the Alaska National Wildlife Reserve and provide support for biofuel targets.

But is this optimism justified? Today's FT has a secong long article on peak oil, the idea introduced by Shell geologist, Marion King Hubbert that oil production is bound to peak and then decline. Hubbert accurately predicted the peak of US production in the 1960s. His followers see global oil production peaking in the next decade or so, followed by shortages--and according to some--panic in the streets. Even sober analysts believe that the capacity of Saudi Arabia to increase oil production at its mammoth Ghawar field is limited. And such knowledgeable Texans as T Boone Pickens are believers in peak oil. Last week, Pickens plunged down $2 billion as a one quarter downpayment, on 2500 turbines he is installing in the Texas Panhandle to build the world's largest wind farm.

Optimist or pessimist, it's clear that oil capacity is under stress and high prices are probably here to stay. Even under the most optimistic scenarios, renewable sources won't replace oil for decades. The key question is how quickly will markets work to lower oil usage and drive investment in the technologies needed when the wells begin to run dry.

Exurban Wasteland

Is the exurban era over? For the last sixty years, American urban development has been characterized by a relentless, outward surge of population to the edge. While the reasons are complex, the top two are easy loans courtesy of Federal programs like Fannie Mae and cheap gas. With housing stalled and gas prices soaring, the peculiar American invention of sprawl may be approaching a crisis. The car culture that supports sprawl made sense at $1.50 a gallon. But now that prices are rising, there is a very real possibility that today's exurbs could be tomorrow's wasteland.

Paul Krugman addresses this question today in an oped that finds the future of urban development, not in India or China but in old Europe. Why? Europe embodies precisely the high density, transportation-oriented-development that may be the answer to sprawl. Krugman points out that Berlin has about as many people as Atlanta but they get around by bus or train, not by car. German families own cars; they just get higher mileage and drive less. The result is a sustainable-and not too shabby--style of living that is less harmful to the planet and a lot easier on the family budget.

Smart growth, as it is known in America, has been around for a while but it has yet to get real traction. Besides cheap gas and plentiful cheap land at the edge, the ideal of high density, eco-friendly development has repeatedly run into the US preference for highways instead of rail, the suburban homestead as opposed to apartments and our system of federalism that has wrought a patchwork of tiny, competing jurisdictions. With low gas prices no longer supporting sprawl, however, the other supports may not sustain it.

What could save the exurbs? High mileage cars will help, but they are not enough. America needs to make a massive investment in rail and other forms of public transporation to link exurban centers which still tend to radiate outward from cities together. To do that, a reform in infrastructure finance is needed. In turn, zoning codes need to change as well to promote higher density development and open space preservation. Currently the very definition of sprawl-separation of residential housing form commercial stores-is baked into tens of thousands of zoning codes around the country. Model zoning codes that promote smart growth should be enacted nationally.

It's a big challenge. But America should start now if it has any chance to forestall what may be major dislocation down the road.

Syndicate content