Pricey crude hurts in all sorts of fiscal ways—but it could also spur crucial investment in alternative fuels
Crude oil prices are again creeping toward triple digits. With the dollar hitting a new low against the euro Nov. 20 and OPEC saying it won't boost production, the price of a barrel of West Texas Intermediate spiked $3.39, to a settlement record of $98.03. In overnight electronic trading, crude futures broke the previous trading record, reaching $99.29 a barrel. It was the third consecutive day of rising prices, which are up 61% so far in 2007.
As speculative fervor continues to test the $100 mark, fears that expensive oil could spur inflation and cripple consumer spending is spreading. Pricey oil—coupled with the subprime crash, shaky credit markets, Wall Street turbulence, tensions with Iran and a feeble dollar—could be the catalyst that topples the U.S. economy into recession.
Which Horse to Back?
But doom and gloom is not the only upshot of $100 oil. In fact, many analysts see pricey oil as the jolt the economy needs to cut greenhouse gas emissions and foster more energy efficiency. That's because as oil gets costlier, the incentives rise for new investments in energy efficiency and renewable options. Initiatives such as plug-in hybrid cars or cellulosic ethanol become more cost-competitive. Higher oil prices also ratchet up the pressure on Congress for new laws supporting renewable, cleaner energy sources on a larger scale.
"The top line point about expensive oil is that it gins up everyone's desire to do something about it," says Josh Dorner, a spokesman for the Sierra Club. "The task is to figure what [energy] policy works best for the environment and consumers alike, and to invigorate the search for alternatives."
There is wide disagreement on which alternative energies would help meet demand as oil prices remain high. Advocates of corn ethanol say it's cleaner than gasoline, and that more production can help revitalize the U.S. corn belt. But while the government has provided vigorous support of corn ethanol, it is losing ground in terms of public perception because of the fuel's economic and environmental costs. More promising, experts say, is ethanol produced from sources like sugar cane and wood chips, which is more energy efficient and better overall for the environment. Other energy alternatives that stand to gain from oil's price surge are plug-in hybrid vehicles, power co-generation (combined heat and power), and fuel cell technologies.
Which energies get support depends in part on how policy helps shape the marketplace. This summer both the Senate and the House of Representatives passed energy bills that include provisions like raising the renewable fuel standard and boosting energy efficiency. Dorner and others say those bills could win more favor in an era of $100 oil, especially as consumers are squeezed.
But experts warn against hasty and imprudent policies: "$100 creates a 'Don't just stand there, do something' attitude," says Craig Pirrong, professor of finance and energy markets at the University of Houston's Bauer College of Business. "My worry is that politicians throw money at everything and lurch toward policies that aren't practicable. They could direct the money based on a political calculus, not an economic one."
Business Stays Ahead of Policy
Some advocates of renewable energies warn that staking changes in energy policy on $100 oil is impractical, given that market's volatility. "Oil prices have been perfectly random for 148 years—get used to it," says Amory Lovins, chairman and chief scientist of the Rocky Mountain Institute, an energy research laboratory in Snowmass, Colo. "One-hundred-dollar oil would be psychologically helpful but you don't need it; we can get off the stuff at $15."
Lovins says that because businesses can profit by going greener no matter the price of oil, the most promising developments in energy efficiency and alternatives are emerging from the private sector. Companies like Wal-Mart Stores (WMT) and Boeing (BA) have begun trying to cut greenhouse gases through changes in supply chain management and the development of more efficient products. Overall, businesses are discovering that becoming greener benefits the bottom line. "The private sector is doing what it's good at—making money," says Lovins. "Washington will be the last to know, but business is solving these problems already."
Digging Deeper for Oil
But the search for more energy supply as oil prices rise does not end with energy efficiency and renewables. As long as oil flirts with $100, exploration for new reserves will continue to ramp up. Companies now have powerful incentives to drill into harder-to-reach supplies in tar sands or deep waters, even if the oil is heavier and of lower quality than light, sweet crude oil. Brazil's national oil company, Petrobras (PBR) for example, just announced a large crude discovery (BusinessWeek.com, 11/19/07) nearly five miles beneath the ocean surface.
"The cheap oil environment of the mid-1980s through the 1990s failed to encourage exploration and production investment," says Stephen Schork, an energy consultant in Villanova, Pa., and editor of The Schork Report, a daily energy newsletter. "As oil prices rise, we're starting to wake up from that and see a real push for other sources of crude."
Companies like ExxonMobil (XOM), BP (BP) and ConocoPhillips (COP) are already upping their investments in such difficult projects. Exxon Chairman and Chief Executive Officer Rex Tillerson advocates that the U.S. allow more domestic drilling (BusinessWeek.com, 10/26/07), pointing out that in a world of scarce oil supply and high prices, alternatives are only part of the answer. "While all economic energy sources should be pursued to meet growing demand, fossil fuels—oil, natural gas and coal—will continue to play the predominant role well into this century due to their scale, reliability and affordability," Tillerson said Nov. 12 at the World Energy Conference in Rome.
The other impact of high oil prices, of course, is that prices fall. As high prices change the decisions consumers, businesses and investors make, demand will decrease and at least some air could come out of the inflated price. "This market is unsustainable," says Fadel Gheit, senior energy analyst for Oppenheimer (OPY). "When the price of anything doubles in a short period, people and economies can't adjust that quickly. The question is not if prices will come back down; it's when, and by how much."