How to Kick the Oil Habit

By MICHAEL D. LEMONICK

If anyone harbored any doubts that hybrid cars are hot, last week the 2005 Tokyo Motor Show put them to rest. Carmakers practically ran over one another promoting their versions in attempts to catch up with Honda and Toyota, the technology's pioneers. Companies such as Mercedes-Benz, BMW, Mazda, Mitsubishi, GM, Volkswagen and Porsche showed new models or talked about plans to sell them by the end of the decade at the latest. On display were not only regular hybrids, the kind powered by gasoline engines mated to electric motors, but also variations adding hydrogen to the mix and a system that puts electric motors at the wheels. The frenzy to churn out hybrids and their technological cousins is so fierce that archrivals GM, DaimlerChrysler and BMW have teamed up to build a research and technical center in the Detroit suburbs. And Ford is so desperate to fill 200 open jobs in its hybrid program that it's competing with Toyota to hire engineers from the software and aerospace industries. The stakes are high: Ford and GM announced third-quarter losses of nearly $2 billion combined last week, thanks in part to plunging sales of SUVs.

It doesn't take a Ph.D. economist to figure out why that's happening--just a stop at the gas station, where prices are roughly 25% higher than they were a year ago, and where, despite a slight easing as the effects of hurricanes Katrina and Rita recede, they will probably go higher still before too long. Home heating oil is 50% higher than last year too, and natural gas will probably jump similarly. Those dramatic increases, Federal Reserve Chairman Alan Greenspan said in a speech last week, will create a significant drag on economic growth "from now on."

The silver lining, said Greenspan, is that as oil gets more expensive, other energy sources and technologies that use less oil will become more competitive. And that's exactly what's happening. Says Daniel Yergin, chairman of Cambridge Energy Research Associates and author of The Prize, the 1991 best seller about the history of oil: "There's a lot of technological innovation kind of bubbling that really has captured the imagination and obsession of a lot of people." The question is, Are we moving fast enough?

The good news is that as the price of crude has headed steadily upward, technological innovation has driven down the cost of alternative energy sources. Wind farms cover hillsides near Palm Springs and Altamont Pass in California and are springing up in the breezy Midwest and on the Atlantic Coast too. Solar cells can churn out electricity at around 25-c- to 35-c- per kilowatt-hour, falling but still a multiple of the cost of energy from coal-fired power plants. Canada is extracting oil from the tar sands of Alberta for an amazingly efficient price of $15 to $20 per bbl., and the technology exists to convert the U.S.'s huge supply of coal into petroleum. This process, called coal liquefaction, creates a fuel that could power cars and is starting to look economically feasible. Conservation, too, benefits from technology: auto companies are suddenly getting more serious about boosting mileage by replacing steel components with materials like strong, lightweight carbon fiber.

At the same time, oil companies, worried that these changes could leave them behind, are starting to think of themselves instead as broad-based energy companies. "Shell and BP are already headed in that direction," says Amory Lovins, director of the Rocky Mountain Institute, a think tank that advocates a radical restructuring of the energy economy. Shell has become the largest seller of biofuels, he says: "We're talking about new processes for turning woody, weedy plants like switch grass and poplar--also crop waste like wheat straw--into cellulosic ethanol."

If this explosion of innovation has a problem, however, it may be that the developments are coming too late to allow a smooth transition to the postpetroleum era. Hydrogen fuel cells, ethanol from vegetable matter, solar cells, wind power, synthetic gasoline from coal--all could make a dent once they are available in sufficient quantities. But that won't be for years, maybe decades, says Richard Heinberg, a professor of culture, ecology and sustainable community at the New College of California in Santa Rosa and the author of The Party's Over: Oil, War and the Fate of Industrial Societies. Twenty years in the future, he argues, "regular old oil will still be the dominant fuel. We'll just end up paying more for it."

As consumers, we need time to make adjustments--often very expensive ones--to the new technologies. Not everyone can afford to junk a two-year-old SUV to buy a new hybrid. Most people can't afford to abandon houses built in developments 100 miles out in the countryside when oil was cheap. And although energy and power companies are investing in new technologies, they can't create a massive new infrastructure overnight. Coal liquefaction, nuclear power, wind power--"all of these things need an enormous lead time," says Heinberg. The problem with the free market, in short, is that while it may sort things out over the long run, people have to cope in the short run. "Price signals," he adds, "come much too late, and we will endure a tremendous amount of economic and social hardship that could have been averted if we'd acted sooner. We could see the equivalent of the Great Depression, fueled by extreme oil and natural-gas prices."

Things would have been different if we had been pouring money into alternative energy for the past couple of decades, as we did in the aftermath of the oil shocks of the 1970s. Back then, despite the ribbing Jimmy Carter got for appearing on TV in a cardigan and calling for sacrifice, there was a clear sense of national emergency. That crisis receded, thanks in part to conservation and investments in energy efficiency and in part to the worldwide recession the oil shocks helped trigger. As a result, a barrel of oil costs 30% less today, in inflation-adjusted dollars, than it did at its peak in 1981. This is not the first time the world has run out of oil. Yergin says it's the fifth or sixth.

But this may be the real thing. Matthew Simmons, chairman of Simmons & Co. International, an energy-industry investment-banking firm, says, "This is a shortage where demand actually exceeds supply. The two shortages in the '70s were artificially induced." Back then, OPEC was powerful and disciplined enough for Middle East oil producers, angry about U.S. support of Israel and the Shah of Iran, to be able to simply turn down production. But now a confluence of trends has made oil shortages inevitable, not optional. One is the unexpectedly rapid expansion of India's and China's energy needs. Fadel Gheit, senior vice president for oil research at the New York City investment firm Oppenheimer & Co., says, "They created the tight market we're in."

Another problem is refinery capacity. Even an unlimited supply of crude is useless if it can't be refined into gasoline, heating oil and other fuels. And for the past 20 years, says Gheit, the refining industry has been losing money--or has barely made it: "[The industry was] closing refineries because they weren't profitable." That set up a situation in which a hurricane like Katrina or Rita or last year's Ivan could trigger a shortage by putting even a few of the remaining U.S.-based refineries out of business for a few weeks. Yet the industry is reluctant to build more refineries, Gheit says, because "they've been burned before. It's like the boom and bust in real estate."

Beyond that, the supply of crude is not unlimited. Opening the Arctic National Wildlife Refuge or the coast of Florida for drilling, which congressional Republicans have been pushing for, is a relatively short-term fix. And the more oil that is removed, the more expensive the cost of extracting the remaining oil becomes. At some point--possibly as early as 2010--production will therefore reach a peak, though not necessarily a sharp one, and then gradually start to decline. "The problem," says Simmons, "is that the global economy and the U.S. economy are structured on the assumption that the oil supply will only increase."

The upheaval could be alleviated significantly if the government had a long-range policy for moving beyond oil. But no Administration or Congress in the past 25 years has put one together because such a move would involve spending money and offending powerful interest groups. Republican Senator Pete Domenici of New Mexico, chairman of the Energy and Natural Resources Committee, astonished environmentalists last month when he suggested that federally mandated auto-mileage (CAFE) standards had to be reconsidered. But because that could cut into automakers' profits, there's virtually no chance that such legislation would pass. Tax incentives for switching to alternative energy may be easier. Republican Representative Richard Pombo of California, chairman of the Resources Committee, says, "There is already an incentive to develop new technology. You just have to send a real clear signal that the Federal Government wants to." But a wholesale push to change our highway culture is unlikely. European countries decided long ago that it paid off to interfere in the free market by discouraging oil consumption and subsidizing mass transit, but that's not the American way.

The one thing that will probably cushion the blow of this new and permanent energy crisis is something old, with an air about it of discomfort and duty: conservation. There's nothing particularly sexy or chic about consolidating shopping trips, carpooling, turning the thermostat down in winter and up in summer, or biking to the office and back, but it does work. In the early '80s, in the midst of soaring oil prices, we doubled the average efficiency of cars, furnaces and insulation. Katrina and Rita might not have pushed us into another energy-crisis mind-set yet. With the inevitable price jolts to come, though, we're heading that way soon enough.

With reporting by Reported by Lisa Takeuchi Cullen, Coco Masters/New York, Eric Roston/Washington, Joseph R. Szczesny/Detroit, Michael Schuman/Tokyo