Economy & Business

The Flexible-Fuel Solution

Rand Paul offers a way to bring down long-term oil prices.

Negotiators in Geneva appear to be sleepwalking into a SunniShia nuclear arms race, so a bad neighborhood — as former Israeli prime minister Ehud Barak so memorably described the Middle East — is likely to get much worse. The Islamic State’s Mesopotamic marauding is adding industrial quantities of fuel to the fire. Since the region is home to some two thirds of world conventional oil reserves, oil prices are unlikely to stay at two digits for very long.

That’s unfortunate, since low oil prices — while depressing for the shale patch — are certainly fantastic for the majority of Americans. High global oil prices erode disposable income and act as a tax hike on Americans, while funneling billions upon billions of dollars to some of the world’s worst regimes. It’s been nice to have a respite from $147 oil, but policymakers should be well aware that, despite reduced imports, it is still the regimes of OPEC that — by both their action and their inaction — have the most influence over the price of oil. While we’ve never imported more than 15 percent of our oil needs from the Middle East, what we have imported and still do import from the region — due to the fungibility of the commodity — is the price of the black liquid. Analysts wait with bated breath for Saudi oil minister Ali al-Naimi’s statements because they know that if the Saudis choose to tighten the taps significantly, oil prices will climb.

The increase in U.S. domestic oil production due to the shale revolution makes all the more stark the 40-year freeze we have had in OPEC production capacity. The oil cartel, which sits on 72 percent of the world’s cheapest and easiest-to-lift oil — $2.50 a barrel is the Saudi production cost — produced 30 million barrels a day in 1974, and lifts less than that today. Assuming OPEC’s reported reserves are not inflated, a deliberate choice to keep production capacity over four decades much smaller than reserves allow is in keeping with normal cartel behavior: keeping supply tight to maximize revenue, and periodically cranking up production (or refraining from cranking it down) to allow the market to flood in order to bankrupt competitors. The short-term cost to Persian Gulf royals of lower prices such as we have today is well compensated by the long-term gain, especially as Asian customers lock themselves into a dependence on Saudi Arabia by building refineries optimized to the Kingdom’s products, namely medium and heavy sour crude (shale-patch oil is sweet and light).

This dynamic makes a great deal of sense for OPEC regimes, rentier states that need to ensure that the long-term price of oil is high in order to balance their oil-fueled national budgets, while keeping domestic spending high enough to dissuade their subjects from storming the palace doors. It is not such a good deal for the United States and its allies, since oil-price spikes tend to trigger economic downturns. That there will probably be increasing hits to supply from wars and terrorism in the region will only make things worse.

There is a way out of this conundrum, and it involves the shale patch. The reason oil-price spikes send our economy into a tailspin is that most cars and trucks are open only to gasoline or diesel. As a collective, OPEC, with its lowest marginal cost of production, acts as a monopolist in the oil market. Our petroleum-dedicated fuel tanks allow OPEC to act as a monopolist in the transportation-fuel market as well. While the vagaries of geology mean there is not much, despite the admirable efforts of American entrepreneurs, that can be done about the former, the latter is a problem that can be solved. Opening our fuel tanks to fuel competition would allow fuels made from natural gas, coal, and biomass to be arbitraged against petroleum-based fuel. Eventually, such competition would serve to keep oil as moderately priced as its competitors.

Shale-patch production has so tremendously increased the supply of natural gas that, even with oil in the mid two digits, on an energy-content basis natural gas is still three times as cheap. Cheap liquid fuel made out of natural gas, such as methanol, can be used in flexible-fuel vehicles that cost less than $100 extra to manufacture than do gasoline-only cars and that allow drivers to decide at the pump whether to fuel with gasoline or with something else based on comparative price or other considerations. Natural gas can also be used directly, as compressed natural gas, and it can be used to generate electricity, which fuels plug-in hybrid and electric vehicles.

Opening the transportation-fuel market to competition has long faced a chicken-and-egg issue: Why should automakers sell cars that are open to a fuel not retailing at many fuel stations, and why should fuel stations retail a fuel if cars aren’t warranted to use it? Flex-fuel vehicles overcome the technical part of this conundrum, because they can be fueled with gasoline while fuel stations catch up with the new fuels at their leisure. A bill just introduced by Senator Rand Paul (R., Ky.) answers the question for automakers. The no-subsidy, no-mandate Fuel Choice and Deregulation Act would give automakers the option of reducing their existing hefty and expensive fuel-economy obligations by opening at least half the vehicles in their fleet in a given model year to fuel competition of some sort. The bill is technology neutral, letting the market rather than government decide which fuels and drivetrains make most sense at any given time. It would serve to throw open America’s fuel tanks to competition and keep prices at the pump low over the long term. It is a critical policy shift that would insulate our economy from the volatility of a region in which the likelihood that the Arab Spring becomes an Islamic nuclear winter rises by the day.

– Ambassador R. James Woolsey is a former director of Central Intelligence, co-founded the U.S. Energy Security Council, and chairs the board of the Foundation for Defense of Democracies. Anne Korin is a co-director of the Institute for the Analysis of Global Security (IAGS) and an adviser to the U.S. Energy Security Council.

 

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