Low Cost Energy & American Productivity
September 23, 2003

Lewis E. Lehrman

If the twin scourges of mankind are sin and ignorance, America's energy problems, according to the political and environmental left, are caused by our sins against nature. In this view, the problem goes all the way up to the Oval Office, which is supposed to be living in sin with the energy industry. If the left is correct, America's energy situation must be hopeless. Federal policy, no matter what it is, cannot be counted on to transform fallen human nature.

On the other hand, there are grounds for hope if one believes that the biggest obstacle to sensible energy policy is not sin but ignorance. Missing from the media energy debate are plain answers to the basic questions: How much energy do Americans use? What kind is it, and what does it cost? Where does it come from? When we know the answers to these questions, we can frame a sensible energy policy--which basically amounts to answering the same questions, but replacing is and does with should. Then it becomes clear that the most basic issue is not a technical one. Rather, the American people face fundamental choices about energy, on the supply side and the demand side, which will decide the way they will live their daily lives for generations to come. Such questions should not be decided by energy technicians.

1. How much energy do we use? We can get an idea of how much energy we use, and why, by comparing the total energy used by the United States since 1950 (detailed statistics start in 1949) with other related economic variables: particularly the total size of the economy, the number of workers, and the average cost of fuel in "real" or inflation-adjusted terms (see chart).

The comparison is revealing in a number of ways. First, the sustained economic growth in the 1950s and 1960s was accompanied by stable or declining prices for energy. This period of large American families and generally one household breadwinner was still an era of rising prosperity. It is my argument that these facts, among others, covering a time when the United States was the world's leading oil-producing country, were, to an important extent, the result of careful and responsible design by policymakers--and that cheap energy should once again be a key goal of economic policy. Along with proper tax, budget, regulatory, and monetary policy, a cheap energy policy will lead to sustained, rapid, long-term economic and employment growth.

The same comparison of energy use and other key economic factors shows that after 1970--when OPEC seized and held oil market power--four recessions were triggered by a sharp rise in energy prices. OPEC had temporarily succeeded in colluding to restrict the oil supply. Such collusion would be illegal in any U.S. industry. Thus, if we desire rapid growth and full employment, our policy goal, unlike OPEC's, must be low, steady real prices of energy.

Second, the comparison also reveals an interesting but overlooked fact about Americans' use of energy: For the last 20 years, total U.S. energy use has paralleled the growth of U.S. employment. This contradicts conventional wisdom in two ways. On the one hand, it is conventional to speak in terms of energy use per capita, meaning averaged over the whole population. And of course over the very long run, energy use and population should broadly move together. But over shorter periods, especially when the age structure of the population is changing, energy use clearly tracks growth in employment much more closely than population. Workers need to commute to work, for example, but many outside the labor force, like children and retirees, don't. Thus, growing the supply of energy slightly in excess of demand contributes to full employment policies.

On the other hand, most economists, including many in the Department of Energy, still extrapolate heavily from the experience before 1980, assuming that the demand for energy automatically increases with real GDP. They look at it this way: Over the whole period from 1950 to 2002, real GDP multiplied by a factor of 5.6, while total energy use multiplied by 2.8. So the economy's energy efficiency roughly doubled in the last half-century. Extrapolating from this, they also expect energy use to grow about half as fast as real GDP in the future.

But this conventional view overlooks an important change in the way American employers and workers use energy. From 1950 to 1973, both employment and energy-use-per-worker increased by about 50 percent; as a result, total energy use more than doubled, growing nearly as fast as real GDP. Overall U.S. energy efficiency in producing real GDP was about the same in 1972 as it had been in 1954. But from 1973 to 1982 (during which the OPEC cartel sent oil prices up about ten times by restricting supply), energy-use-per-worker fell, reversing half the previous increase. Unemployment rose during this period from about 5 percent to about 11 percent at the peak in 1982. Since then energy-use-per-worker has been steady. Of course, many factors were involved, notably the response to changing energy prices. But when such variables are accounted for, employment is the only factor with a one-for-one relationship to total energy use over the whole period since 1950. It seems, therefore, that there is a provisional answer to the question "How much energy will America need?" The answer: "About the same growth in energy use as in employment." From the standpoint of government policy, another plausible way to formulate the answer is to say cheap and growing energy supplies are a crucial part of an effective policy of full employment at rising real wages.

Understanding this allows us to sidestep the acrimonious posturing so prevalent in the global energy debate. If, as in Japan and Germany, our population were expected to shrink by 20 percent over the next 50 years, pledging to reduce the use of both energy and hydrocarbons would be easy. Fewer people mean fewer workers, and fewer workers will use less energy. But while Japan and Germany have been sliding down the world population tables, the United States expects continued population growth. Fifty years ago, the United States was the third most populous nation in the world (after China and India). Today, with a population 90 percent larger than in 1950, we are still third. And demographic forecasts, based on birthrates and immigration, suggest the United States will still be third in population 50 years from now. The U.S. population is expected to increase by about one-half during that time. America on balance still believes in growth, unwilling yet to accept long-term national suicide like Europe and Japan.

Now, if energy use keeps step with employment, U.S. energy efficiency will continue to climb as in the past 20 years--but total U.S. energy use will also rise. Those Malthusians who favor an absolute reduction in U.S. energy and hydrocarbon use haven't yet spelled out to the American public what that would mean: namely, a corresponding decline in employment, a decline in the standard of living from what Americans would otherwise enjoy, and ultimately, a decline in U.S. population. It is true there are extremists who advocate zero or negative growth. But are the American people, properly informed and free to choose, willing to embrace it?

2. What kind of energy do we use and at what cost? Here the first fact is that the bulk of U.S. energy (about 86 percent in 2002) is still supplied by fossil fuels--coal, petroleum, and natural gas. Renewable energy sources--chiefly hydroelectric, wood, and alcohol--have contributed as much as 9 percent of total energy (in 1950 and again in 1982), but have dwindled to only 6 percent of total energy used, chiefly because of a decline in hydroelectric power. Solar, geothermal, and wind power, combined, amount to about 0.5 percent of total energy--because, in general, they are not and will not soon be competitive with fossil fuels on total cost and reliability. Other new age fuels, like hydrogen, have the same problem (see chart).

The second central fact about energy use is that the only significant reduction in reliance on fossil fuels has been the result of increasing nuclear electric power--which went from 0.4 percent of total U.S. energy consumed in 1970 to just over 8 percent in 2002, cutting American use of fossil fuels from 94 percent in 1970 to 86 percent in 2002--despite the fact that no nuclear power plants have been built in this country in a generation. The United States and the European Union are similar in their reliance on petroleum (39.8 percent in the United States vs. 42.7 percent in Europe) and natural gas (23.7 percent here and 24.5 percent in the E.U.). The main difference is that reliance on coal is 8 percentage points lower and on nuclear energy 7 percentage points higher in the E.U.

While the pattern is similar, the absolute amounts of energy used per capita and per worker are nearly twice as high in the United States. Once again, the reason is an objective one, grounded in hard reality. The European Union, with a population one-third larger than the United States, but with only one-third the surface area, has a population density four times as high--almost as high, in fact, as China's. Working Americans need more energy for basic tasks like commuting to work. (While some elites wish to prohibit or restrict commuting, or make it much more costly, the American people at the polls should decide the policy.) Also, while Western Europe is blessed with a mild climate, America routinely faces much greater temperature extremes. In general Americans therefore use more energy on heating in winter and cooling in summer than do Europeans or Japanese. This summer, Europe got a taste of a typical summer in many parts of the United States, and over 10,000 people died in France alone.

On the other hand, the United States would do well to follow the example of Europe by increasing the use of nuclear power and mobilizing new technologies for its safety and efficiency. The E.U. and the United States are similar in the share of total "primary" energy input that is processed to deliver electricity to customers: 14.3 percent in the E.U. and 13.2 percent here. However, the current state of technology is such that the energy input necessary to produce electricity with fossil fuels is about three times the net output of electric power. About 39 percent of total U.S. energy is used to generate electricity, but about two-thirds of the fossil fuels used to generate electric power are lost as waste heat. The math suggests, therefore, that increasing the share of U.S. nuclear power in electricity generation from 20.6 percent to the European level of 33.3 percent would free up about 15 percent of total U.S. energy use--all fossil fuels. Nuclear fuel is the cheapest in relation to its energy content--costing barely half as much as coal--but no nuclear plants have been licensed since 1979. (The relative capital costs of nuclear plants and the disposal of processed fuel must be considered. Still, the U.S. government, innovative financiers and engineers, if given the chance, will be a fair entrepreneurial trade for the present Luddite prohibitions on clean-burning nuclear power.)

This naturally raises the question of cost. Put in common units, nuclear fuel in 2003 costs about 50 cents per million BTUs (roughly the energy content of nine gallons of gasoline), compared with about 85 cents for coal, $4.90 for natural gas, and $4.50 for crude oil (see chart below). At the current crossroads, a policy of cheap energy therefore militates in favor of nuclear energy and coal (because, unlike Europe, the United States can produce all it uses and more). The cheapness and heat efficiency of coal explains why its use has continued despite unsuccessful official efforts going back to the Middle Ages to curb its use because of smoke and fumes. Today, improving clean coal technology can yield cheap power and a clean environment. One marvels at the rise of the standard of living made possible since medieval times by cheap fuel.

Traditionally, the most expensive fuel has been petroleum. Petroleum could remain relatively expensive and ubiquitous for so long because, for compelling reasons, there were no rivals to replace it in the transportation market (where two-fifths of America's energy is used). Because of weight considerations, burning gasoline (or other refined petroleum products) in an internal combustion engine remains by far the best method of converting fuel to motive power. Other fuels are competitive in the generation of heat and electricity, where the weight of fuel and equipment is not a major factor.

For decades natural gas was cheaper in North America than petroleum; but the so-called "gas bubble" popped, and natural gas has recently become more expensive than petroleum. The main reason is that nearly all recent additions to electricity-generating capacity have been plants fired by natural gas, encouraged as a more ecologically desirable fuel than coal. Thus, the demand for natural gas increased. But our technologically advanced natural gas producers have been restricted by statutes, regulations, and environmentalist lawsuits from finding domestic natural gas except in a few declining established fields. Environmentalists have ramped up the demand for "clean-burning" natural gas just as they have shut down the supply. Should we be surprised by the rise in price? Moreover, for three years, manufacturing jobs have been declining every month. This is no accident. U.S. heavy industry and basic materials manufacturing are heavily reliant on natural gas. The current process of adjustment to the high price of natural gas--euphemistically called "demand destruction" by economists and environmentalists--simply means throwing skilled manufacturing people out of work in natural gas-dependent, basic industries (such as chemicals). Shifting to nuclear energy for electricity would relieve the pressure on natural gas, dropping its price, and making it more available to heat homes and supply manufacturing needs. Such a policy, combined with "smart grid" technology, microgeneration and distribution, and interstate integration and development of the grid, would solve many of the present problems of electricity transmission and the volatility of its cost.

3. Where does our energy come from? To get an idea of the answer, we need to consider U.S. production vs. consumption of energy, the difference being net imports. Before 1970, energy was cheap, not least because growth of U.S. energy use was matched by growth in domestic production of energy. But total fossil fuel production has never exceeded the 1970 level, and the only net additions to U.S. energy output have been due to nuclear energy.

The reasons for such an outcome are in large part self-imposed. From 1971 to 1980, energy price controls simultaneously stimulated energy consumption and curtailed energy production (while indirectly subsidizing OPEC). Since U.S. producers received far less than the world price, energy production moved abroad. Since 1973, U.S. crude oil output has fallen almost 40 percent. Moreover, net imports of petroleum and petroleum products have risen to about two-thirds of domestic usage. With so much of our supply coming from undependable, insecure, and unstable parts of the world, our standard of living and national security are similarly unstable and vulnerable to political upheaval.

Federal environmental laws and lawsuits are an important cause of our restricted energy production and infrastructure. The growing difference between our total energy use and U.S. energy production is of course equal to net imports. Our policy of severely restricting the permitting and production of most forms of energy has magnified OPEC's ability, depending on the business and political crisis cycle, to raise the world price of crude oil. In sum, price controls first caused a bulge in oil imports in the 1970s, but those imports stayed high as U.S. producers were increasingly prevented from finding and pumping known and discoverable onshore and offshore domestic oil and natural gas deposits (see chart).

These basic facts about U.S. energy use suggest that a policy of restoring greater energy independence and maintaining inexpensive energy is not only possible but necessary--if Americans truly desire increased national security, a vibrant basic materials industry, and rapid economic growth. American energy producers have the technical ability to carry out such a policy; and we also have the technology to do so while keeping the environment safe.

Let us call this political platform cheap gas, cheap oil, cheap electricity. The policy would have three basic facets: (1) Government intervention to double the share of nuclear power in electricity generation, thereby reducing pressure on supplies and prices of fossil fuels (and incidentally emissions of hydrocarbons). (2) A concerted national trade and security policy to prevent monopolistic collusion by foreign energy producers, especially in crude oil--and thus to restore more U.S. energy independence. Since collusion is not tolerated in any domestic industry, why must we tolerate collusion abroad against a vital U.S. interest, especially by oil-producing countries whose political existence depends to a large extent on U.S. military power? (3) As part of the same effort to increase U.S. production, a vast expansion of legal permissions for drilling for crude oil and natural gas on public and private lands should be enacted. Energy processing and transmission industries, such as refineries, pipelines, and distributing networks, must gain rights of way, increased freedom of pricing, and thus the access to capital needed for growth. The characteristics of an inspired regulatory regime for U.S. energy would thus be diversity, reliability, and redundancy.

Of course, energy policy is only one facet of a sound overall economic policy. Our national security is linked in innumerable ways to accessible, secure, and preferably cheap energy--suffice it to say, abundant energy is the sinew of basic materials manufacturing and the fuel upon which our industries and armed forces rely. Moreover, economic history shows that America has, from its founding, been a high-wage country, which is a good thing--owing in large measure to the existence of a cheap, secure factor of production called energy.

While recession and slow growth now give way to cyclical recovery, a simple "recovery" is not good enough. We need a policy designed for sustained, rapid, economic growth for the next generation. Combined with President Bush's supply-side tax policy, an unselfconscious supply-side energy and regulatory policy will lead to abundant and cheaper energy, growth of economic opportunity, and full employment. While energy prices have probably peaked for the near term, this is no time to become complacent. Our policy should aim to keep prices down for the long term, by increasing domestic supplies instead of relying on demand destruction.

But it is not just prosperity that such a policy aims at. Adam Smith taught us well that defense comes before opulence. The national defense policy of President Bush is inspired and forward looking. But prudence counsels that to desire the Bush Doctrine is to desire the indispensable means to make it effective. Only rapid growth in national wealth can finance both a rising standard of living for all Americans at home and a successful Bush Doctrine abroad.

Lewis E. Lehrman is partner at L.E. Lehrman & Company and co-chairman of the American Security Project.