How conservation could actually make us--gulp--even more reliant on foreign oil.
By Austan Goolsbee

(FORTUNE Magazine) – EVERY ADMINISTRATION SINCE Richard Nixon's has railed against foreign oil--at least when prices are high. President Bush recently called our dependence on the stuff a "foreign tax on the American dream." Indeed, the promise of energy independence helped the Energy Bill land on President Bush's desk at the end of July. As Senate Majority Leader Bill Frist chimed in, "When we rely on other nations for more than half our oil supply, we simply put our security at risk."

A basic tenet underlying such comments is that, quite apart from the need to stimulate new domestic energy sources, we must reduce our overall demand for oil if we are to reduce our dependence on foreign sources of the stuff. To that end the bill provides more than $1 billion of subsidies for hybrids and home energy conservation. But there's a problem with this line of thinking. It ignores the way oil pricing really functions, and put simply, it won't work. The costs of pumping oil in the U.S. are among the highest in the world, and the costs in the Middle East are the lowest. So in fact any significant reduction in U.S. demand would hit domestic sources hard but do little to change the amount of foreign oil we buy.

At first glance, weaning the country from foreign oil through conservation seems straightforward. The U.S. imports about 25% of its oil from OPEC. Reduce demand 25%, and we could cut OPEC loose. Though consumer-goods analogies are imperfect, think of the oil market as a bit like going out on a hot day with sodas you bought at the grocery store for 50 cents a can, when they cost $1 a can from a vending machine at the beach. If the grocery store is the domestic supply and the vending machine is the foreign, then reducing demand for soda to the number of cans you brought yourself will end your dependence on foreign soda. But unfortunately, it wouldn't be the OPEC oil we would stop buying if our demand fell. In today's oil market, it's as if the grocery store sodas cost 50 cents but the vending machine sodas cost only 10 cents. In that case, reduce the demand for soda enough, and you will stop buying soda from the grocery store entirely. You would buy cans from the grocery store only if the vending machine couldn't serve all your needs (or if a cartel of vending machines was restricting production, as it were).

In the world of oil, we're the proud sellers of some very high-priced soda. Most oil that was cheap to produce from the U.S. was used up long ago. Today the largest potential sources of oil in North America, be they the shale deposits in Utah and Wyoming, the oil sands of Alberta, or the deep-water offshore pools in the Gulf of Mexico, are all much more expensive than the cheap oil coming out of the Middle East. Our average production costs in some places are as high as $15 per barrel. Cost estimates for places like Iran and Saudi Arabia go as low as $1.50 per barrel.

If U.S. demand (which is the largest of any country in the world) falls substantially, it will drive down oil prices. When prices are low, many U.S. oilfields become too expensive to keep open. That is why our lowest share of foreign oil imports in the past three decades came in the early 1980s--when oil shocks drove prices to record highs and encouraged development of the higher-cost U.S. sources.

Without question, driving down oil prices by reducing our demand could reduce the total amount of money going to the Middle East. We should be aware, though, that this reduction will cause far greater damage to the world's high-cost producers of oil, such as those in the U.S. than it does to OPEC, and there is little chance it will reduce the share of our oil that comes from abroad. If we are to seriously contemplate lowering our dependence on foreign oil, we must find a way to reduce the cost of producing alternative energy sources. Hopefully, sources like wind, solar power, or hydrogen fuel cells will eventually get to a point where they become cheaper than fossil fuels. But the sad reality is that while we might be able to cut greenhouse gas emissions by reducing our demand for oil, Bush's "foreign tax on the American dream" is not getting cut anytime soon.