Fool's Gold in Alaska

Amory B. Lovins and L. Hunter Lovins

From Foreign Affairs, July/August 2001

Summary:  Alaskan politicians have used every oil-price rise since 1973 to push for drilling beneath the Arctic National Wildlife Refuge. But even putting environmental questions aside, refuge oil is unnecessary, insecure, economically risky, and a distraction from the real energy debate. Market solutions that enhance efficiency can provide secure, safe, and clean energy services at much lower cost.

Amory B. Lovins, a physicist, and L. Hunter Lovins, a lawyer and political scientist, founded and lead Rocky Mountain Institute, a market-oriented, nonpartisan, nonprofit applied-research center in Snowmass, Colorado. They are long-time consultants to major oil companies and have advised the Department of Defense on energy security.

In those eight years, U.S. oil productivity soared by 52 percent, demonstrating an effective new source of energy security and a potent weapon against high oil prices and supply manipulations. The United States showed that a major nation could respond to supply disruptions by focusing on the demand side and boosting its energy productivity at will. It could thereby exercise more market power than suppliers, beat down prices, and enhance the relative importance of less vulnerable, more diversified sources of energy.

Drilling proponents today ignore this lesson. Instead, they cite the imperative of displacing Middle East oil to justify drilling in every U.S. site where oil might occur. But even if this imperative existed, refuge oil would be a poor solution. After a decade of drilling and preparation, it could provide only modest, brief relief -- totaling less than one percent of projected U.S. oil needs -- and would cost much more than the efficiency-boosting alternatives. Repaying refuge-oil investments would require oil prices so high that, in the ensuing decade, they would elicit far greater efficiency. Those efficiency gains, in turn, would depress oil prices, displace the targeted imports, and make refuge oil unnecessary. That was what happened in the mid-1980s; repeating the same experiment will yield the same result.

The United States has exploited its reserves longer and more fully than has any other nation, so the essence of its oil problem is that finding and lifting the next barrel typically costs more at home than abroad. A market economy offers three possible solutions to this puzzle: protectionism, trade, and substitution. Protectionism means subsidizing domestic output, which deters efficient use, or taxing imports, which violates free-trade rules. Either way, market principles are scorned, competitiveness wanes, and domestic oil depletion is illogically countered by faster depletion. Most countries opt for the trade solution. Germany and Japan, for example, import all their oil and are adept at earning foreign exchange to pay for it. They rely on a global oil-trading and transport system so flexible that even the Persian Gulf War did not create lines at gas stations. Trade is hardly novel to the United States, which imports many vital commodities, including 52 percent of its oil last year at a cost of $109 billion. But if concerned Americans fear that higher costs or thorny questions of political instability make importing unattractive, a third option exists: substitution.

Substitution means displacing oil with more efficient use of oil or alternative energy sources. This strategy reduces dependence in the quickest and cheapest way and maximizes competition and innovation. Indeed, the United States has already partly followed this course; its oil productivity has already doubled since 1975. But the efficiency-promotion strategy could have gone much further if U.S. policymakers had not quickly combated and suppressed it after the 1986 oil-price collapse. (In that year, for example, a rollback of car and light-truck efficiency standards doubled U.S. oil imports from the Persian Gulf and wasted one "refuge" of oil.) If the United States had continued to conserve oil at the same rate that it did in 1976-85 or had simply bought new cars that got 5 mpg more than they did, it would no longer have needed Persian Gulf oil after 1985. Instead, policy in the 1980s discouraged energy efficiency, which was officially characterized as an intrusive, interventionist burden of curtailment and sacrifice. Efficiency also appeared needless when the 1986 price crash ushered in a decade of cheap oil, while deep budget cuts crippled technological innovation in energy productivity. Today, the dramatic gains in energy efficiency that the United States launched during the Carter years have been forgotten. Many journalists and political leaders no longer remember that efficiency gains are not only possible but profitable. Yet despite the neglect of efficiency from 1986 to 1996 (when efficiency began a sudden resurgence), the nation has still cut $200 billion off its annual energy bill.

U.S. oil imports crept back up in the late 1980s, spurred by low prices, abundant supplies, corporate inattention, and policy neglect. If the first Bush administration had required in 1991 that the average car get 32 mpg, that measure alone would have displaced all Persian Gulf oil imports to the United States. Instead, the United States fought a war that deployed tanks moving at o.56 mpg and aircraft carriers moving at 17 feet per gallon. That effort cost the United States more than it would have cost to save (through investing in efficiency technology) all the oil imported from the Gulf. That lesson was ignored as Congress stalled most efficiency initiatives in the 1990s. By 2000, oil imports had rebounded to their record 1977 level, and oil prices spiked once more. The three-member Alaskan congressional delegation, chairing three of the four chief congressional committees controlling public lands, again pressed for drilling in the refuge. On January 22, 2001, aides to President George W. Bush claimed that California's electricity crisis showed that the nation desperately needs more fuel. In fact, California has no shortage of oil, and only one percent of its electricity comes from oil; nationwide, only two percent of oil is consumed to generate electricity. Curiously, the administration's response to the nation's supposed "energy crisis" has been to reject the notion of "doing more with less," the very definition of energy efficiency. It has halved key budgets for efficiency research, increased future power needs by 13 billion watts by weakening cost-effective air-conditioner standards, and centered its supply-side strategy on seeking -- against all odds -- congressional approval to exploit refuge oil.

OIL ROULETTE

The refuge is one of the planet's most inhospitable and remote locations. For oil companies to invest profitably there, it must hold a lot of oil. Furthermore, world oil prices must stay high enough for a long enough time to recover costs and earn profits. But even official proponents of drilling have found its economics dubious.

In 1998, the U.S. Geological Survey (USGS) found that better (and fourfold cheaper) production technologies could probably draw 3.2 billion barrels from the refuge.1 This oil would be worth recovering only if its long-term price were at least $22 per barrel in West Coast ports (the destinations that the USGS picked for its price calculations). But until it spiked up from $13 per barrel in 1998 to $30 per barrel in late 2000, Alaskan oil did not exceed that level for 8 years. That spike was a blip, not a trend. In April 2001, Alaska's Department of Revenue forecast a steady price drop from $22 per barrel in 2001-2 to less than $13 per barrel in 2009-10 -- the earliest that any refuge oil might flow. Alaska's latest price forecast for 2020 is $18 per barrel. The U.S. Department of Energy predicts that world oil prices will not reach $23 per barrel until 2020; nearly all industry forecasts are lower.

But it is no longer necessary to speculate which forecast is correct; they all tend to converge on the prices discovered in the futures market. Alaska's forecasters agree that this convergence is unaffected by price spikes such as the one in 2000. Their projection for 2004-10 accordingly stays under $16 per barrel. (One of the world's largest oil companies does not even consider any prospect requiring a delivered price of more than $14 per barrel.) According to the USGS, that price is also the threshold below which there is probably no economically recoverable oil beneath the refuge. Even that threshold may be too high; volatile oil prices make drilling especially risky, requiring higher returns and prices in any high-cost area where exploration and development will be slow and difficult. And if the federal government were to demand lease fees, such as the multi-billion-dollar revenues that the Alaskan delegation inserts into budget bills, or if taps needed more maintenance, the price threshold would rise.

Some drilling advocates argue that technological advances in finding and extracting oil can still make refuge oil profitable. Those advances are indeed real and astoundingly rapid. From 1987 to 1999, they increased the discovery of new U.S. oil resources by an estimated three-fifths. One-ninth of all U.S. oil reserves discovered since 1859 were found just in the past decade, even as oil prices fell. Better technologies could make extracting refuge oil cheaper -- but those same advances would also cut costs everywhere else, and just about anywhere else is easier and more attractive. Better technology makes global oil more plentiful and therefore cheaper, so it renders high-cost areas less competitive. During the 1990s, this process combined with increasing competition from energy alternatives to halve long-term forecasts of oil prices, which are still falling. The Department of Energy now forecasts that imported oil will cost three-fifths less by 2020 than what the Department of the Interior had forecast in 1987, when it predicted prices hitting $61 per barrel. If oil companies really believed in sustained high prices, they would be drilling everywhere -- and they are not. On the contrary, when oil prices rose from $10 per barrel to $25 per barrel in 1998-99 and lifted the oil and gas revenues of major U.S. energy companies by more than 50 percent, those firms cut exploration and development outlays by 66 percent in the United States (onshore) and 38 percent worldwide. These companies believe that advancing technology will keep the world long awash in oil that is too cheap for refuge drilling to beat.