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Get Ready For Life Without Oil

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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Saudi Arabia isn't the nicest ally to have. The desert kingdom just handed out  a sentence of  1,000 lashes to a blogger for running a website devoted to freedom of speech. Not exactly the kind of regime we want to have in our circle of friends, especially once you figure in their financial support for Islamic State and other radical Islamist groups.

But you go to war with the allies you have, not the allies you wish you had. And in the global oil price war against Russia and Iran, Saudi Arabia is the U.S.’s indispensable ally. By continuing to pump the black stuff at an undiminished rate, the Saudis are repeating the trick they pulled in the mid-'80s, allowing oil prices to plunge in response to Western supply increases, thus depriving their rival (Iran) and ours (Russia) of revenue -- and, in the process, temporarily tanking the U.S. shale industry.

It would be nice if we could escape this cycle -- to say nothing of limiting global carbon emissions. But oil remains the indispensable commodity, without which industrial civilization will be thrown back to the coal age -- or worse. So we’re stuck with the Saudis, stuck with Russia and Iran, and stuck with our dependence on a single nonrenewable pollution-generating resource.

But what if we had a real-life Iron Man, to build us magical “arc reactors” and solve our energy needs forever. Well, we do have the man who inspired the movie version of Tony Stark --Tesla founder Elon Musk.

Musk and Tesla haven’t invented the arc reactor, but they are making rapid incremental improvements to a more down-to-earth technology -- the lithium-ion battery. Tesla’s planned “gigafactories” in Nevada and (possibly) New York will harness economies of scale to an unprecedented degree, building on improvements that have slashed battery-based energy storage costs during the past two decades.

Just to give you an idea of how fast battery costs have declined, here is a chart (via futurist Ramez Naam) showing how the amount of energy that can be stored in lithium-ion batteries per $100 rose from 1991 to 2005:

That data is from a 2009 study by Duke University. Nor did storage efficiency stop after 2005; according to Naam, the cost of electric-car batteries declined by 40 percent from 2010 to 2013. The Tesla gigafactories are projected to drive costs down at an even faster rate.

These declines, unlike the recent 50 percent drop in oil prices, are not temporary. They are driven by increasing demand, which spurs technological progress -- not by reduced demand, which lowers the oil price. In the case of oil, new technologies such as fracking allow us to get more oil, but always at a higher cost than before -- in the case of batteries, technology just keeps getting better and better.

A 2011 McKinsey & Co. analysis reported that battery prices would have to drop by about three-quarters to make electric cars cost-competitive at gas prices of $2.50 per gallon. But that was four years ago, and battery prices have continued falling. We could see cost-competitive electric cars taking over the road in as little as a decade. That’s how fast the cost trend is moving.

Of course, that will require extensive modifications to our transportation-energy infrastructure -- we’ll need to replace gas stations with charging stations. That’s why Iron Man – er, Elon Musk – has decided to allow other companies to use Tesla's patented technology free of charge. When other car companies get in on the electric-car game -- such as General Motors, which just announced a new electric car, the Chevy Bolt -- the incentive increases to build more electric-charging infrastructure. The more charging infrastructure gets built, the more incentive there is for consumers to buy electric cars, and so forth -- a classic case of a network effect.

Electric cars won't free humanity from the need for oil. We also use oil for making plastics and other products, and for heating. Heating oil will eventually be supplanted by solar power, of course, for which Musk’s batteries will also come in handy (bye bye, utility industry!). And we use oil for jet fuel, which can’t easily be replaced with batteries.

But ground transportation still makes up the bulk of our oil use. So when batteries advance to the point where oil is no longer used for cars and trucks, the Saudis, Russians and Iranians will find themselves selling what is suddenly a niche product. And simultaneously, the U.S., Japan, Europe and other energy importers will find themselves free from the yo-yo of global oil prices.

In other words, it’s less than two decades until we are free from the yoke of the petrostates and their nasty, backward regimes. Go Iron Man! …Um, I mean, Elon Musk.       

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net