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Financial Times: Treating oil addiction

Published: February 25 2008 02:00 | Last updated: February 25 2008 02:00

Driving is as American as apple pie. At more than 9m barrels a day, gasoline accounts for almost half of US oil demand, and more than a 10th of that of the world. Capitol Hill wants to curb this. Use of biofuels, mainly ethanol, is to be expanded five-fold to 2.4m b/d by 2022. In addition, new cars must achieve 35 miles per gallon by 2020, up from 21 mpg today.

Will it make a difference in 10 years? Ethanol provides only two-thirds the energy gasoline does, and the dominant corn-based variety requires a lot of energy to make. So the extra 1.3m b/d of ethanol possibly on the market by 2017 would actually displace only 700,000 b/d of gasoline consumption.

With regard to better vehicle efficiency, Michael Canes of the LMI Research Institute has analysed the potential gains. Assume average mpg for new vehicles improves evenly, and the total vehicle pool turns over at a rate of 7 per cent a year. Then adjust for factors such as more traffic on the roads and the fact that greater fuel efficiency tends to encourage more driving. By 2017, average actual fuel efficiency might be 23.5 mpg, implying “savings” of another 1.3m b/d. In theory, then, biofuels and less thirsty cars should more than offset an expected 1.5m b/d of incremental US gasoline demand by 2017. The savings would equate to perhaps one seventh of global incremental oil consumption.

How realistic is this benign view? Vehicle efficiency forecasts look robust – just reducing the weight of America’s bloated cars would help. The annual increase in fuel efficiency mandated by Washington – about 3 per cent – might seem ambitious. But vehicle manufacturers did much better than that in the decade after fuel efficiency standards were first passed in 1975, clocking up a 5.5 per cent improvement each year.

A biofuels breakthrough, however, requires big technological strides, and quickly. Start-ups such as Coskata, backed by General Motors, are developing such wonders as swamp bacteria that turn old tyres and other waste into fuel. But expanding a laboratory process into a nationwide industry is a huge challenge.

The bigger near-term risk to oil prices is the economy. Gasoline demand growth in the US has slowed to zero already. It turned negative in the recession at the start of the 1990s. China and the Middle East are now the centres of incremental demand, fuelled in part by domestic price subsidies. A US recession seems unlikely to slow them to a stop but could have a noticeable short-term effect and recalibrate demand forecasts beyond that.

Washington’s policy will have a real impact nonetheless, on a 10-year view. GSW Strategy Group, a US energy consultancy, points out that all the presidential frontrunners have committed themselves to initiatives such as greenhouse gas cap-and-trade schemes. A bubble may be developing in alternative energy. But that does not mean all the technologies it spawns will be duds. And their use would not be confined to just one country – China, for example, also worries about energy security.

If the history of the last oil shock is anything to go by, the one thing that could really undermine efficiency efforts would be a sudden drop in the price of crude. This time, however, fears for the climate and security concerns are creating, if not an alliance, at least a coalition of the willing encompassing such diverse interests as green activists and defence hawks. That even Detroit’s dinosaurs seem to view greener cars as one way of reinventing themselves suggests the trend will hold.

Beyond the near term, therefore, the efficiencies being planned now will affect the pricing of oil futures more and more. In that context, the current stance of Opec keeping the market tight, even if that fuels efforts to make gasoline from bugs, perhaps makes more sense. If the trends pushing greater energy efficiency look unstoppable, the oil producing cartel might as well maximise profits up front.

Copyright The Financial Times Limited 2008

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