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Oil Independence: Realistic Goal or Empty Slogan?

By David L. Greene and Paul N. Leiby
Oak Ridge National Laboratory

Our nation’s dependence on oil is a threat to our economy and our security.  And yet the belief that it is either impossible or impractical to achieve “energy independence” has been gaining currency.  A report by Resources for the Future declares that “Energy Independence is Unrealistic”.  The Wall Street Journal asserts that energy independence “…may be among the least realistic political slogans in American history.”  A task force of the Council on Foreign Relations declares the feasibility of achieving energy independence “a myth”.  These pessimistic assessments follow from incorrectly defining energy, or oil, independence as either zero oil imports or zero oil use.  Neither is necessary to achieve a truly meaningful state of energy independence.  Defined properly, oil independence is definitely achievable but will take time, persistence and strong yet practical policy measures.  The good news is that once we seriously commit to solving the problem our energy security will gradually but steadily improve until energy independence is achieved, long before we stop using or importing oil.

What is oil independence?  Merriam-Webster defines independence as, “not subject to control by others”.  To control is to “exercise restraining or directing influence over.”  Therefore, to achieve oil independence as a nation we must reach a state in which our nation’s decisions are not subject to the restraining or directing influence of oil producers.  A measurable definition must also reflect our uncertainty about future oil market conditions and include a quantitative statement of how much the potential costs of oil dependence must be reduced.  The following is put forward as a reasonable starting point and possibly an adequate, measurable definition.

“The annual economic costs of oil dependence will be less than 1% of U.S. GDP, with 95% probability, by 2030.”

Oil dependence is fundamentally an economic problem, albeit one with extremely important military and foreign policy implications.  Yet, if there were no economic consequences of oil dependence the foreign policy and military implications would be minimal.  The size of our current strategic oil reserves is adequate for military oil independence.  In fiscal year 2005, the Department of Defense consumed 133 million barrels of petroleum.  The Strategic Petroleum Reserve stands at 688 million barrels, enough to supply the requirements of the DoD for five years at the 2005 rate of use. 

What are the economic costs of oil dependence?  As Professor Morris Adelman of MIT has tersely and precisely stated:

“The real problem we face over oil dates from after 1970: a strong but clumsy monopoly of mostly Middle Eastern exporters cooperating as OPEC.” 

The U.S. economy suffers three kinds of economic costs as a result of its oil dependence and the actions of the OPEC cartel (and other oil producers who may cooperate with them):

1. transfer of wealth,
2. loss of ability to produce
3. disruption losses. 

When producers raise prices above competitive market levels by the use of market power, there is a transfer of wealth from oil consumers to oil producers.  U.S. citizens become poorer, oil producers become richer.  The wealth transferred to oil producers is pure surplus (profit).  It need not be reinvested in producing more oil.  It can fund health care or terrorism, economic development or nuclear weapons programs, education or repression.  The size of this economic loss depends directly on how much oil we import.  In 2005 wealth transfer cost the U.S. economy between $100 billion and $150 billion.

The transfer of wealth does not necessarily reduce our GDP but the two other categories of oil dependence costs do.  When the price of any key input to production increases, our economy’s ability to produce given the same endowments of capital and labor shrinks.  It doesn’t matter whether the scarcity is physical or the result of market power.  The amount of GDP loss depends on how much oil we consume, how much we produce, and on the sensitivities of domestic oil demand and supply to the price of oil.  A reasonable range for the potential GDP costs incurred in 2005 is from $10 billion to $50 billion.

Disruption costs occur only when there is a sudden, unexpected jump in the price of oil.  They are caused by temporary dislocations in the economy as a result of an oil price shock.  The size of disruption losses depends on the flexibility of production, the ability of wages and prices to adjust quickly, the expectations of consumers and producers, monetary policy and, of course, the importance of oil to the economy.  While there is greater uncertainty about the magnitude of these costs, a plausible range for 2005 is from $50 billion to $170 billion. 

A reasonable range for total economic oil dependence costs in 2005 is $175 to $330 billion (Figure 2). The midpoint amounts to 2.25% of U.S. GDP.  The average cost of a barrel of oil was $50 in 2005.  Costs for 2006 will be greater.  Unless we change course, our future oil use and oil imports will be much larger, exposing our economy to even greater costs.

How can we reduce the costs of oil dependence to less than 1% of GDP with 95% certainty?  A comprehensive, robust and sustained policy strategy that reduces our demand for oil and increases the supply of substitutes is required.  Strong but practical policies are essential, such as raising passenger car and light truck fuel economy standards by 75%-100% by 2030, eliminating oil use for space heating, and meaningful restraints on carbon emissions.  The continued growth of our economy will be a key ally for any strategy.  Achieving sustainable oil independence will also require advanced technologies, such as low-cost biofuels from cellulosic biomass, clean diesel engines, plug-in hybrids, and perhaps eventually hydrogen-powered vehicles.   But it will not require zero oil use or zero oil imports.  Analysis we have done indicates that decreasing oil use by about one-third and augmenting supply by about one-third would be sufficient to achieve oil independence by 2030. 

Oil independence is about reducing our vulnerability to oil dependence costs to an acceptable level.  It is not about eliminating oil imports or eliminating oil use.   Achieving oil independence will take time.  It is not possible to achieve oil independence next year or even in five years.  The good news is that once we get started we will see steady improvement all along the way.  Achieving oil independence will require strong but practical policies addressing both energy demand and supply.  Maintaining oil independence will require sustained effort. 

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