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Why high oil prices haven't cut demand

Despite a doubling in the price of oil in the past year, U.S. demand continues to rise. Big energy savings won’t happen without major changes in the economics of conservation.  By John W. Schoen
Despite higher fuel prices, demand hasn't fallen as it did after the 1970s oil shocks. Energy researchers say it will take greater economic incentives to boost energy efficiency and cut consumption.
Despite higher fuel prices, demand hasn't fallen as it did after the 1970s oil shocks. Energy researchers say it will take greater economic incentives to boost energy efficiency and cut consumption.
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With gasoline prices breaking $2 a gallon and oil prices headed for $60 a barrel, the drive to conserve energy should be getting another big push. After all, each barrel of oil saved is just as good as a new one found underground. And every new “nega-watt” achieved through conservation is just as good as the mega-watts produced by new power plants.

But so far, that doesn’t seem to be happening. And experts say big energy savings won’t be achieved without major changes in the economics of conservation for both businesses and consumers. The good news is that technological advances offer a wealth of opportunities to cut fossil fuel consumption.

“Our technologies (for improving energy efficiency) are vastly better and the savings are getting bigger and cheaper even faster than the stunning advances for finding and lifting oil,” said Amory Lovins, CEO of the , an energy research and consulting firm.

The same was true 30 years ago. When the Arab oil embargo first choked off U.S. supplies in 1973 and prices surged, oil consumption dropped by 5 percent over the next two years. In late 1978, when the Iranian revolution sharply cut U.S. oil supplies again, demand dropped by 10 percent over the next five years.

The adjustment was painful; higher oil prices sparked a prolonged period of high inflation that hurt the economy and the stock market. But much of the drop in demand came from figuring out how to do more with less. Appliances now consume less electricity. Homes are better insulated and high-efficiency furnaces produce more heat with less fuel. Today, it requires half as much oil to produce a dollar of gross national product than it did 30 years ago.

“We are using 27 percent less energy per person for residential uses — home heating, cooling and lighting — than we did in the 70s,” said Dr. Marilyn Brown, director of the Energy Efficiency and Renewable Energy Program at the Oak Ridge National Laboratory. “And new homes have increased in size by 50 percent over the past 30 years. That’s a phenomenal improvement."

Still guzzling
But though the U.S. economy continues to make gains in energy efficiency, the pace has slowed since the mid-1980s. Improvement in the gas mileage of the U.S. auto fleet has stalled, and advances in residential and commercial construction practices and standards have not kept pace with the technologies that would help save even more energy.

As a result, U.S. oil demand keeps growing. In its latest , the U.S. Department of Energy predicts the nation’s appetite for petroleum products will continue rising — ending this year 1.9 percent higher than last year. Even as prices soar, demand .

So why have consumers largely ignored the latest surge in crude prices? One reason may be that consumers are conditioned to expect price spikes to be short-lived, said Clifton Green, a finance professor at Emory University’s business school.

“People now are just more cynical about the price of oil,” he said. “They figure, ‘Oh, it won't stay high; it’ll come back down; they’ll start digging in Alaska; they’ll find some more.’ So consumers are less apt to change as quickly."

Moreover, Americans aren't feeling anything like the pain of the 1970s; adjusted for inflation, oil would have to hit $80 a barrel to match the peak prices of 25 years ago.

The topic of energy conservation is also getting little attention in the presidential campaign. That’s largely because memories are still fresh of the political failure of the “less is more” philosophy of the late 1970s, when President Carter addressed the nation in a sweater and implored Americans to turn down their thermostats.

In fact, many of those involved in trying to cut energy use avoid the word “conservation” altogether — a term that brings to mind personal sacrifices like buying a smaller car or making fewer trips to the mountains in your SUV. The emphasis now is on “efficiency” — maintaining the same standard of living and little change in lifestyle, all while using less energy.

No sound-bite solutions
Still, even as higher oil prices begin to take their toll on the global economy, the problem of cutting energy use defies sound-bite solutions.

“If you’re looking for a single thing that’s going to solve all the problems it's not going to happen that way,” said Dr. James McMahon, head of the energy analysis department at Lawrence Berkeley Labs. “What’s going to happen is we're going to get 5 or 10 percent improvements in a dozen things. And then all of those added up together are going to give us a very different product.”

On top of the list of things that are ripe for efficiency gains is the automobile, which makes up the biggest single category of energy use in the United States. Gasoline mileage standards, first mandated by Congress in 1975, did raise the efficiency of cars. But those gains were largely wiped out by the surging popularity of light trucks and SUVs in the 1990s — a trend driven in large part by the higher profit margins these vehicles offer car manufacturers. “Powertrains got a third more efficient since 1981,” he said. “But only 1 percent of that gain was captured in the fuel saving. The rest of that was performance.”

But the technology to boost gas mileage even more is already available. The list includes everything from improved internal combustion technologies to tires that produce less rolling resistance.

“The key is to make (cars) lighter out of modern materials that are light but strong,” said Lovins. “So the vehicle can be big, light, efficient and safe all at the same time. You can save oil and lives simultaneously.”

Relatively small improvements in the mileage of the U.S. car and truck fleet would have a substantial impact on roughly 375 million gallons of gasoline consumed every day. Reducing that consumption would save consumers two ways: first, they would drive further on the same tank of gas. And since the U.S. refining industry is straining to meet demand, cutting consumption would help cool the overheated gasoline markets.

But energy researchers say those gains won’t happen until there’s a compelling economic reason for consumers to make a change. And because an overall improvement in energy efficiency is achieved from a collection of many small gains, there is no single beneficiary who sees big direct benefits.

For example, Lovins calculates that the cost of gasoline makes up just one-eighth of the cost of car ownership. So better mileage by itself may not provide enough economic incentive for a driver to trade in a relatively new car. McMahon figures the money saved on electric bills from more efficient home appliances over the past 30 years amounts to about $50 per household. Spread over 100 million households, that’s $5 billion in savings.

“If there was an industry that was capturing that as a benefit,” he said, “there would be really strong incentives to lobby to continue that and make it larger. But it’s distributed over so many consumers that they basically don’t notice.”

Building a better refrigerator
Still, the efficiency improvement in small appliances — another big category of energy consumption — has been one of the success stories of the past 30 years. Through a series of staged milestones, the federally sponsored Energy Star program, launched in 1992, has helped cut electricity consumption by appliances.

Energy Star’s success raises a critical question about the role of government in saving energy. Those involved in the program credit its success with the consensus reached among manufacturers, regulators and conservation advocates.

“(The solution) is not necessarily the heavy hand of government,” said McMahon. “In many cases, it’s a negotiation with manufacturers over what’s possible and how long it will take to come to some agreement. In the appliance standards world, these things take place years in the future and are negotiated with plenty of lead time so that all the manufacturers can get up to speed.”

The high cost of energy by itself doesn’t seem to provide enough incentive to change consumer buying patterns. The popularity of an energy-saving refrigerator, for example, depends heavily on the price of a megawatt where you live, according to Earl Jones, head of Energy Conserving Products for General Electric’s Energy Star Division. (MSNBC.COM is a joint venture of Microsoft and NBC, which is owned by GE.)

“The real key here is not just to focus on energy because that’s going to be hit and miss,  depending on where you are,” he said. “You have to be in a position to package energy with something that all consumers will want."

Low hanging fruit
After three decades of improvements, it remains to be seen just how much more efficiency can be wrung out of cars, buildings, appliances and factories. Some have argued that because the easy gains have already been made, further improvements will be harder — and more costly to consumers. This theory argues that the low-hanging fruit of energy efficiency has already been picked.

But researchers working on the problem say that metaphor misses an important dynamic in the push to squeeze more out of each barrel of oil or megawatt of electricity: the “technology tree” bears new fruit every year.

“The rule of thumb used to be that if you looked at an energy system, you could figure out a way to save 30 percent of it and it would probably be cost effective,” said McMahon. “Twenty-five years later, if you look again, you could still save 30 percent and it would be cost effective. Why? Because the technologies and the production processes have changed or gotten cheaper.”

Keeping the pace of technology moving costs money. The Bush administration has allocated more money for research in longer-term solutions like hydrogen and fuels cells. But basic research in boosting fuel efficiency and developing alternative energy sources in the United States has not kept pace with other developed countries — in both the public and private sectors, said Brown.

“We’re spending less on energy research than we were 20 years ago,” she said.

That means further incentives may be needed to spur businesses to commit more capital. The deregulation of the electric power industry, for example, has made it harder for power companies to recover research and development spending through higher electric rates, said Brown.

“There's a risk to coming out with new technologies, and it may or may not be worth it,” said McMahon. “If you’re trying to maximize your profits with certainty, you do less basic research and count on borrowing or buying the research from someone else.” 

But by doing so, American companies risk a replay of the 1970s, when Japanese car makers captured big chunks of the market with gas-sipping models that Detroit  had to scramble to emulate.