How to Kick the Oil Habit Gas prices are soaring, pipelines are burning, oil supplies are tight. Here are four ways to fix the mess before the well runs dry.
By Nicholas Varchaver Reporter Associates Abrahm Lustgarten, Jenny Mero

(FORTUNE Magazine) – Every day brings another culprit. On Aug. 5 it was word that crude exports from Russia's massive Yukos Oil might be in jeopardy, as authorities there said they were once again freezing the company's accounts. The news pushed the already stratospheric price of oil up to $44.41 a barrel, shattering a 21-year record--as it sent the Dow Jones industrial average hurtling down 163 points.

Just three days earlier it had been a different kind of news--al Qaeda's reported plans to attack U.S. financial institutions--that whipped oil prices into a frenzy. The truth is, on any given day, any number of events could trigger a similar spike--a pipeline explosion in Iraq, political protests in Venezuela, union turmoil in Nigeria, terrorist attacks in Saudi Arabia. Sometimes the mere whisper of an incident is all it takes. And each of those bumps sends ripples of pain through the stock market, through oil-reliant industries such as airlines, and finally to consumers, who complete the trifecta of suffering when the cost registers at the pump as $2-a-gallon gas.

Americans aren't used to viewing Russian tax disputes and Nigerian labor protests as driving forces in our lives. We're the most powerful country in the world, right? But such seemingly trivial and distant events pose a severe risk to the U.S.--not to its safety but to its well-being. In a post-9/11, safety-obsessed world, U.S. energy security--making sure we have enough oil to run our economy--remains shockingly vulnerable.

Production capacity is stretched so thin, demand is so high, and supply is so fraught with uncertainty that we're just a few riots or explosions away from another oil crisis. The lack of spare capacity is eerily similar to what it was in 1973, says Peter Schwartz, a former scenario planner for Shell. That year, for those not old enough to remember the oil embargo, prices tripled within months, and gas lines became a symbol of national impotence.

As it is, turmoil overseas has helped propel oil prices up more than 40% during the past 12 months. Risk, in other words, has become a part of the fundamental equation when it comes to the price of oil--not a temporary "premium," as some characterize it. Indeed, even without a major disaster, some analysts now believe we're likely to see $50-a-barrel oil before we see $30 a barrel again.

To make matters worse, we're more vulnerable now than we were in 1973. Back then the U.S. imported 30% of its oil. Today 60% comes from foreign sources. And while our strategic petroleum reserve might protect us from running out for a while, it won't save us from a long-term shortage.

Much as we might like to, we can't blame it on OPEC. After all, Americans have been on a two-decade oil pig-out, gorging like oversized vacationers at a Vegas buffet. Yes, China is gulping more and more oil. But the U.S. has increased its already world-leading consumption by 20% in just the past decade. And there's every chance it'll get worse.

High prices and disruptions in supply aren't the only problems. Some veteran observers, like investment banker Matthew Simmons, think we are nearing the point--if we're not already there--at which the world's supply of crude peaks and then begins to decline. (Simmons, by the way, is no ponytail-wearing radical. The 61-year-old Houston oilman has advised the 2000 and 2004 Bush presidential campaigns and Dick Cheney's secret energy task force.) Even the optimists believe the start of the downward slope is only 35 years away. Frankly, it doesn't matter who's right. Three decades is precious little time to reconfigure the world's energy system.

The truth is, anyone who seriously tries to tackle the problem of energy security has to deal with the awkward fact that pulling a string in one place only unravels something elsewhere. So, for example, Canada's bountiful tar sands provide a huge new source of "unconventional oil." But freeing the oil requires using natural gas, which the U.S. economy is growing ever more thirsty for too. And since most new electricity plants run on natural gas, you can't discuss one without considering the other.

Unfortunately, the prognosis for natural gas is only marginally better than for oil. Just a few years ago it was being promoted as the cheap and plentiful alternative. But natural gas isn't so cheap anymore--it went from about $2 per million BTUs in the late '90s to more than $6 today. And it won't always be so plentiful here. The U.S. produces about 85% of its own natural gas, but net imports will rise 100% between 2000 and 2020, according to the Department of Energy--and 1,000%, if you believe the International Energy Agency. To accommodate the imports, we'll need to invest some $220 billion in pipelines and terminals to convert liquefied natural gas, which can be shipped from far away by supercooling it into viscous form. Both spark intense resistance from environmentalists and not-in-my-backyard types.

The need for gas imports also means the U.S. will face the prospect of a gas version of OPEC, argues Amy Jaffe, associate director of the James A. Baker III Public Policy Institute at Rice University. Russia and Iran alone control 42.6% of the world's natural-gas reserves. Throw in Qatar and Saudi Arabia, and the figure rises to 61.3%. Says Jaffe: "By 2020 they're going to be pretty much in control of that market." Not only did we not learn our lesson with oil, it seems, but we're now ready to repeat the experience with natural gas.

That provides yet more proof--as if we needed it--that we have to act now.

We've certainly jawboned long enough. Every President since Richard Nixon has vowed to free America from reliance on foreign oil. And--no surprise--George W. Bush and John Kerry have both touted their energy plans in the current campaign (see box). Indeed, the biggest applause during Kerry's acceptance speech at the Democratic convention came with a line about energy security: "I want an America that relies on its ingenuity and innovation, not the Saudi royal family."

There's no shortage of rhetoric--or good ideas. The problem is political reality. Opposing camps have been locked in decades-long standoffs over ideas now known only by acronyms. Many in the GOP, for instance, fight hard for ANWR--shorthand for drilling in the Arctic National Wildlife Refuge--which might yield a million barrels of oil a day. Democratic hardliners demand increases in the corporate average fuel economy (CAFE) standards (miles-per-gallon requirements for cars), which have barely been adjusted in 20 years. And then there's the real third rail of American politics, raising the gas tax by a buck or more a gallon, which advocates claim would make the biggest dent in oil use--and opponents insist would cause rioting in the streets.

So sensitive is the idea of a gas tax that the Bush/Cheney campaign has dug up Kerry's support a decade ago for a 50-cent tax and is using it as the basis for an online gas-tax calculator labeled "How Much Will John Kerry Cost You?" Polls repeatedly show Americans against such a levy, typically by nearly two-to-one margins.

"There are certain things politically that you don't break your lance on," says former Democratic Senator Tim Wirth of Colorado. "One is CAFE. You don't break it on ANWR. You don't break it on gas taxes. None of these is going anywhere." Each year, he says, intrepid legislators "mount up on their steed, put on their armor, lower their lance, and ... they go charging into the wall. It's just unbelievable. Every energy bill does that. And the knight gets blown off his horse, skewered on the lance, and nothing happens. That's where we are today."

And that's why, as FORTUNE has taken stock of the myriad ideas and alternatives that can begin the process of freeing us from the grip of oil, we have applied a political as well as a technological reality check. The goal: a real-world plan that won't derail the economy and has a strong chance of political success--though some proposals will surely meet resistance.

Our proposals target four key areas: (1) Create incentives to improve automobile fuel economy; (2) fund a real alternative-fuel program--particularly for a nontraditional form of ethanol--which could slash gasoline consumption dramatically within two decades; (3) tighten federal efficiency standards and encourage state efficiency programs, which could help cut as much as one-quarter of all electricity use without any sacrifice in quality of life; and finally, (4) encourage the 37 states that don't require utilities to use a minimum amount of wind and solar power to do so.

Will all that be enough to kick our longtime oil addiction? Of course not. Even a far more radical approach won't solve the problem in ten years. Progress will be incremental and take decades. But with the hole we have to climb out of becoming deeper every day we wait, this plan promises what we need most right now--a good start.

Some corporations are already taking innovative leadership roles in those areas, as you'll see below. But to make our plan work, government will also have to do its part. Ideal as it would be to rely solely on market mechanisms, when it comes to transformations on this scale, Washington has typically jump-started the process.

What is perhaps most surprising, considering the magnitude of the problem, is how little these first steps need to cost: We estimate that the proposals below will run about $7 billion to $9 billion per year--though much of that can be offset by eliminating current subsidies and giveaways.

That's peanuts next to the costs that are currently underwritten, via our tax bills, for our oil lifestyle. Even during peacetime U.S. aircraft carriers and destroyers patrol the Persian Gulf--at a cost of $50 billion a year, not counting the Iraq war, according to the conservative-leaning National Defense Council Foundation. Add in the economic effects of oil shocks, the group found last year, and a gallon of gas actually costs more than $5.

Even that is negligible compared with this figure: $1.4 trillion. That's what the U.S. and Canada will need to spend through 2030 on oil and gas--everything from exploration to infrastructure such as pipelines and refineries--to handle growing demand and changing sources of supply, according to the IEA. And that's not even counting the additional $1.7 trillion required for our electricity infrastructure.

No matter what energy reforms we put into place now, there's no way to avoid spending a substantial chunk of this looming $3.1 trillion tab. But the question for America is clear: How much longer do we want to spend our resources simply patching up a system that funnels money to unreliable foreign despots and is based on a commodity we know is sooner or later going to run out?

Here's our four-part plan.


It doesn't take an advanced degree in mathematics to understand that improving automobile gas mileage will reduce oil use. Cars and light trucks make up 43% of U.S. oil use. (Ships, trucks, and airplanes make up another 25%; the remainder goes for industrial and heating purposes.) And with consumers buying 17 million vehicles a year and driving ever more miles, gasoline use is growing.

Hybrids offer the best near-term opportunity to save large amounts of gasoline. The government can help make that happen. Forget the chintzy ghosts of the Chevy Vega or the Ford Pinto. Hybrids--which deliver significantly improved fuel economy by combining a gasoline engine with an electric motor that takes over when the car is idling and, in some cases, driving at low speed--give fuel-efficiency a new, high-tech face.

Consumers have been enthusiastic so far. People are lining up to buy Toyota's Prius. (For more, see "Toyota's Secret Weapon.") But the real market test will occur in coming months as the frugal efficiency of hybrid technology is married to the profligate embodiment of conspicuous consumption: the SUV. The combination may sound like an oxymoron, but given America's love affair with SUVs, which now represent 50% of light-vehicle sales, improving gas mileage here will have a disproportionate effect on oil consumption. Ford and Toyota will soon be introducing hybrid SUVs, and General Motors will offer a hybrid pickup. The automakers are wisely positioning the vehicles as technological marvels rather than puritanical exercises in self-sacrifice.

But for all the positive early signs, these gas-electric machines haven't yet come close to taking hold in the market. The biggest obstacle is price. With their extra technology, they cost around $3,000 more than the comparable nonhybrid.

That's where lawmakers can help. A proposal to offer hybrid buyers a tax credit ranging from $1,000 to $3,000 per car is mired in a congressional conference committee as part of a larger, controversial bill on export subsidies. The Kerry campaign clearly hopes to make a splash with green-minded drivers by promising to up the credit to $5,000. But no matter who wins the election, say political insiders, that would face an uphill battle in the GOP-controlled House Ways and Means Committee.

Our plan would offer a $3,000 incentive only for the first million buyers of hybrids (and thus mollify deficit hawks by capping the spending at $3 billion). That should be enough to kick-start a rush to hybrids and allow economies of scale to begin easing the price differential with gas vehicles.

To avoid swelling the deficit, Congress could pay for this incentive by eliminating several subsidies for the oil and gas industries, whose recent windfall profits (see sidebar) hardly seem to call for federal handouts. Depending on whom you believe, the subsidies range from about $1.5 billion a year (the Department of Energy) to many tens of billions (various environmental groups). Eliminating the percentage depletion allowance, which permits some oil companies to write off more than the cost of their capital investments, and a series of other provisions, could leave more than enough in the federal coffers to support hybrids. The oil industry will, of course, fervently defend such subsidies. But now--with oil topping $44 a barrel--is the time to push ahead.

Let's be clear, though: Hybrids alone will not solve our problems. With 200 million cars and light trucks on the road, each of which has an average life span of 15 years, it could take a decade or more for hybrids to achieve major penetration. At that point we might be saving two million to three million barrels of oil per day--10% to 15% of today's consumption.

But by then we'd be slimming down not from the 20 million barrels we now use each day, but from something closer to the projected 25 million a day we're on track to burn by 2025. Unless every single car in the country is scrapped tomorrow and replaced by a hybrid--a fantasy beyond the dreams even of Green Party members--the new cars won't cut oil use; they'll merely slow the rate of increase.

That's why we can't rely solely on hybrids. Another remedy lies in a nearly forgotten vestige of energy crises past: the gas-guzzler law. It currently imposes progressively greater penalties on cars with 22.5 miles per gallon and less--$3,000 for a car with 17 mpg, for example. But it exempts SUVs from its strictures because they are defined as "light trucks." It's time to acknowledge what we all know: Ford Explorers and Jeep Cherokees driven to the mall by Connecticut soccer moms are passenger vehicles. Congress should apply the gas-guzzler law to SUVs and pickups.

The revenue generated by such a law could be mammoth--more than enough to cover every proposal in this article--and thus we need to be cautious: If applied using the mileage standards for automobiles, according to studies, some $10 billion would be collected in one year. That would gut Detroit's profits. Phasing in the provision over five years and adjusting the mileage standard slightly would give automakers time to adapt.

No question, Detroit is likely to resist. And yet treating SUVs as cars is a one-line legislative fix that's dramatically simpler--and again, more equitable--than reopening the debate over CAFE standards. For years Detroit has successfully blocked attempts (aided by three powerful Michigan Democrats) to toughen CAFE, and there is no evidence of a newfound desire there to tolerate higher mileage standards. GM vice chairman Robert Lutz complains that the rules discriminate against domestic carmakers, which rely more on bigger, less-fuel-efficient vehicles. Says Lutz: "It's the equivalent of fighting obesity by making the clothing manufacturers produce only small sizes." The result: Mileage limits have been stuck since the mid-1980s (albeit with a 1.5-mile-per-gallon uptick now planned for light trucks in 2007). Average fuel economy is actually lower today--25.1 miles per gallon--than it was in 1988.

However, adding SUVs to the same regulatory bag as other cars in essence allows market forces to progressively raise mileage standards. Automakers can build and consumers can buy whatever vehicles they like, though there would be an up-front price advantage to purchasing cars and SUVs with better mpg efficiency.

Congress should also kill one measure that actually encourages excessive gasoline consumption: the bizarre provision that gives a lucrative accelerated tax deduction as high as $100,000 to small businesses that purchase large SUVs such as Hummers.


Alternative fuels, it appears, are finally growing up. For all the New Age connotations of the term, such stuff has actually been around for almost as long as oil. Soon after World War I the British experimented with using Jerusalem artichokes to make fuel, according to The Prize, Daniel Yergin's history of the oil industry.

The chances of moving from fantasy to reality are better than ever--if Congress dramatically expands its support. Here FORTUNE estimates that a $3.5-billion-a-year investment in two key areas could within two decades replace 20% or more of our current oil use.

The lion's share of that spending ($3 billion) should be devoted to a long-term but crucial goal: developing hydrogen technology for cars and electricity generation--an aim that both Bush and Kerry support. The President, in fact, has touted a $1.7 billion initiative to develop fuel cells, which use hydrogen and oxygen to make electricity; Kerry has countered with a $5 billion plan. Until hybrids stole the hype, hydrogen cars were the media darlings. Many experts agree that hydrogen could eventually eliminate the need for any fossil fuels for automobiles and do so without producing greenhouse gases. It may eventually have even more potential as a source of electric power in homes.

But we have a long way to go until we see hydrogen cars jamming our highways. As the American Physical Society put it in a report this past March, we can't make the leap to fuel cells without "major scientific breakthroughs" (such as finding a cheap, lightweight material that can store hydrogen in a car). Many experts question whether GM will be able to meet its target of delivering a "commercially viable" hydrogen car by 2010.

Hydrogen vehicles would be lucky, in fact, to get 5% of the market by 2030, says Joseph Romm, a former Energy Department official and author of The Hype About Hydrogen. In addition to the technical challenges and the billions needed to create a network of hydrogen filling stations, he points out that 95% of hydrogen today derives from natural gas.

The challenge--and part of what we need to spend money on--is developing the means to produce hydrogen from electricity that is generated by, say, wind or the sun instead of fossil fuels. Still, its promise is so great that we shouldn't give up on it.

In the meantime, more readily accessible alternative fuels can serve as a bridge to an eventual hydrogen future. Here, our best bet is biomass--forms of energy that, like oil and coal, are derived from what was once a living plant or animal. Says Dan Reicher, a former Clinton energy official: "Fossil fuel is old biomass. Biomass is simply young biomass." Today the category includes fuels made from a wide array of feedstocks: corn, grass, trees, paper, animal waste--even turkey innards. (The latter isn't a joke. A joint venture of ConAgra Foods and a company called Changing World Technologies has opened a plant in Carthage, Mo., that is superheating turkey offal and reducing it to oil.)

One such biomass fuel that offers tremendous promise, though it will take time to put into wide-scale use, is cellulosic ethanol--which shouldn't be confused with plain old ethanol, the corn-based alcohol best known for the size of its subsidies. Cellulosic ethanol is made from switchgrass, poplar trees, and straw. And it yields more energy than the corn version, says Carnegie Mellon University economist Lester Lave. Like the corn version, cellulosic ethanol can be blended into gasoline and would require minimal modifications to current engines and gas stations.

One group of supporters, the Energy Future Coalition, a bipartisan group that includes ex-Senator Wirth and Republican former White House counsel Boyden Gray, has put forth its own modest proposal. The World Trade Organization has issued rulings against farm subsidies for cotton and sugar. If the rulings stand, the U.S. will need to either end the subsidies or pay billions in fines. As Wirth puts it, "No politician I know wants to take something away from a lot of constituents." He proposes shifting subsidies from cotton and sugar to switchgrass and trees. It would cost the government nothing, but would provide benefits for consumers, farmers, and even the environment (grass and trees take a lesser toll on land than cotton).

Even without the subsidy swap, a $500-million-a-year investment in ethanol could pay off bigtime, allowing for gas spiked with 20% cellulosic ethanol within 20 years. All of a sudden--if you assume that hybrids and other measures hold the line on usage--you can actually reduce gasoline consumption by that same 20%.

Reality check: Like most alternative fuels, cellulosic ethanol is expensive (though subsidies will reduce the cost), and significant production remains at least five years away. As of now only one plant--run by a company called Iogen in Canada (with the support of Shell)--is producing it. Moreover, as economist Lave acknowledges, many tens of millions of acres would be required to grow the biomass. Still, it is promising enough that it earned the endorsement of a Pentagon-commissioned study last year, which looked at how the U.S. can prepare for a post-oil world.


Turn the lights out when you leave the house. It sounds trite. But a broad range of actions in that vein could actually save the U.S. one-quarter of its electricity, say energy experts. (These moves will end up trimming our use of natural gas and coal rather than oil, but remember, it's all part of the same energy equation.) It's a lesson that an increasing number of big corporations are taking to heart--to save money, mostly. But here, too, we need the federal government to push the process along.

The best idea is to focus on efficiency rather than conservation. Though the latter term evokes unfortunate Carter-era images of sitting in the dark in a sweater to gird against the chill, proponents of efficiency argue that we can enjoy our current lifestyle--but use much less power in the process. "The U.S. is the Saudi Arabia of energy waste," says Amory Lovins, an innovator who previewed a new comprehensive energy plan at FORTUNE's Brainstorm conference in July. (His full report is scheduled to be released in September.) By that Lovins means that the very profligacy of our current levels of waste provides a massive and fairly painless opportunity, parallel to the abundance of cheap black gold buried in Saudi sands.

Take refrigerators. Federal standards for their electricity use have had a dramatic impact. The energy saved each year by the nation's fridges at 2001 efficiency standards compared with the 1974 standards is nearly equal to the quantity of electricity produced annually by hydroelectric power in the U.S., says Arthur Rosenfeld, a long-time efficiency guru who is now a California energy commissioner. Nobody is sacrificing here: Refrigerators today are bigger, cheaper, and better. And experts contend that we can get another 30% improvement in refrigerator efficiency.

The government should keep tightening standards for appliances and other equipment rather than fighting them in court, as the Bush administration did in an attempt to block improved air-conditioner standards. (It lost.)

But even without the stick of new federal rules, companies and individuals can save huge amounts with little cost or effort. Russ Leslie of the Lighting Research Center notes that up to 50% of the lighting in offices "is wasted because it's used when people aren't there or there's sufficient daylight." Simply placing a cheap motion sensor in the office can turn the power off when it's not being used and save companies millions. Dow Chemical shaved $2.5 million from its electric bill last year by installing settings that turn employee computer monitors off when not in use. Office-supply retailer Staples is using a system at its headquarters that controls the lighting, heating, and air-conditioning systems at 1,500 stores. The savings: $6.5 million over the past two years.

But the benefit can be considerably more than that. DuPont says it has avoided $2 billion in energy costs over the past decade by tightening efficiency. Fellow chemical giant Dow is saving 800 million BTUs of natural gas a day in a single plant through a computer process that optimizes energy use.

Some companies are integrating efficiency into the design of their facilities. For example, Toyota's U.S. marketing headquarters in Torrance, Calif., is 60% more energy efficient than California's tough statutes require. The building employs thermal insulation and double-paned glass (which also insulates the building). Rooftop solar panels provide 20% of the building's electricity.

So where does the government come in? Right now 22 states have efficiency and renewable-energy programs funded by small assessments on utility bills (typically a surcharge of 1%). Those programs include all sorts of rebates and incentives--for example, California's renewables program chipped in half the cost for the solar roof at Toyota's facility. There are programs that reward improved lighting and more efficient heating and cooling systems. Whoever is President should use his bully pulpit to push states that don't have such programs to adopt them. And the federal government can also encourage them by matching state spending, as recently proposed by the nonpartisan American Council for an Energy-Efficient Economy. The states currently spend about $1.4 billion a year on such programs, according to ACEEE executive director Steven Nadel--an amount that consumers now pay through a tiny surcharge on their electric bills. Our plan doubles that cost to consumers by encouraging every state to adopt an efficiency program. To save a full quarter of our electricity use, it's worth it.


Even more than alternative fuels, renewable-energy technology is improving by leaps and bounds. Wind and solar power aren't the sole solution, but they're certainly part of it. Unfortunately their development is being impeded by the zigzags of Congress. While legislators helped get wind power up and running by enacting in 1992 a subsidy known as the production tax credit, which underwrites wind projects, they have since let that incentive lapse three times in the past five years. Each time the tax credit expires, wind projects grind to a halt--only to come back when the law is renewed. Right now yet another bill to renew the credit (and expand it to encourage solar power) is hung up in a conference committee between the House and the Senate. That kind of political dithering has to stop.

Thirteen states, in fact, have already seized the initiative, requiring that utilities obtain a specified portion of their electricity--typically 2% to 10%--from sources such as wind and solar. The programs, which phase in over years, have been successful even in the unlikeliest locales--such as the oil-soaked heart of the Lone Star State. And there's a bigger surprise: "Wind generation is slightly cheaper" in Texas than getting electricity from natural gas, says Henry Durrwachter, who oversees wind projects for the Texas utility TXU. Texas is unusual: Its strong winds and heavy reliance on natural gas for electricity tilt the price equation in wind's favor. Still, it rebuts the assumption that renewable energy is always exorbitant.

The states that do not have renewable portfolio standards should adopt them. And the federal government can offer tax credits to those utilities that exceed the toughened state requirements.

Costs have dropped 80% for wind projects over the past 20 years, and wind and solar power have become such mainstream businesses that one of the titans of the world power business, General Electric, has bought in. GE, which snapped up Enron's wind-turbine operation, has already turned it into a $1.2 billion business and projects continued double-digit revenue growth. As GE Energy CEO John Rice puts it, "We see these as technologies that will be part of the power-generating portfolios of many of our customers in the future."

Wind and solar won't replace big coal or gas-fired power plants anytime soon. Both technologies provide intermittent power--if the wind isn't blowing or the sun ain't shining, you're out of luck--and neither can be turned on at will. That said, many experts believe that wind and solar could eventually shoulder 20% of the electricity burden. We believe that 10% remains a more realistic target for the next 20 years.

So if we do all this--make a concerted effort to promote hybrids and alternative fuels, pushing efficiency and renewable power--where will we be? As we said, it won't cure our fossil-fuel addictions right away. But it will put us squarely on the road to recovery. We can hold the line on our feverish appetite for natural gas--staving off the kind of vulnerability we now feel with oil. And as for that all-important crude, instead of our consumption growing 25% or more (as it's slated to do now), we could reduce it by 20% from current levels.

That 20% might sound like a modest figure, and indeed, it's only a beginning. But that percentage turns out to be more than the portion of our imports that come from the Persian Gulf. If we do nothing, you can be sure Americans will pay more than just the price at the pump.


SUBSCRIBERS ONLY Read more about oil online, including whether supply has hit its peak and if the U.S. recovery will run out of gas, along with a look inside the head of BP's John Browne.