Back to Previous Editorials >>


The Costs of Fossil-Fuel Dependence
July 12, 2006

Overview


Energy is one of the largest components of the economy. The US will spend over 500 billion dollars in 2006 on the 21 million barrels of oil that we consume each day. Of this amount, over $300 billion will be spent to procure crude from outside the US. The cost of crude, which has essentially tripled over the past five years, has been prominent in the global spotlight and the events of 9/11/01. Driven by international competition for oil and gas and the uncertainty over the stability of the regimes that control the reserves, the market price has greatly exceeded the cost of their production. Even with the recent price increases, the market value still does not reflect the military, economic, health, and environmental costs associated with their production, refining, distribution, and consumption. Without a proper account of these costs, better decisions about our energy future cannot be made. This paper provides a rough assessment of the price tag of our continued addiction to oil with these other effects estimated and included.







Table 1. Cost of crude adjusted for externalities.




Compared to a July 2006 international oil price of $70/barrel, we find that a more representative ‘true’ cost of oil is in the $168 to $214/barrel range. At current costs of refining, distribution, and taxes, this environmental, social, and security premium brings the price of gasoline to between $5.48 and $6.55 per gallon.


In addition, our continued addiction to oil results in millions of lost jobs in the US and billions of dollars that are transferred from the US to unstable regimes around the world each month.





Introduction


Americans are becoming increasingly aware of the impact that rising fuel costs, especially gasoline, have on their livelihoods. There is growing interest in understanding where our oil comes from and who profits from it. They are also anxious about the so-called “War on Terror,” which is arguably carried out to maintain a secure supply of oil for the U.S. This and recent windfall earnings of oil companies have raised serious questions over energy security, the transfer of wealth and jobs, and corporate profiteering.




Figure 1 shows sources from which the US imports oil and the percentage of imports from each source. The US obtains 17% of its imports from the Persian Gulf region, which includes Saudi Arabia, Kuwait, and Iraq. These countries are members of the monopolistic Organization of Petroleum Exporting Countries (OPEC)[1] who together hold two-thirds of the world’s oil reserves and produce about 40% of the world’s crude.









Figure 1. 2005 US import of oil by region. (source: Energy Information Agency, US Department of Energy, and the Heritage Foundation).




Because these oil fields are under the control of foreign governments, as opposed to multinational corporations, OPEC exerts considerable control over the supply and production of crude, influencing the market price of the oil. OPEC has tried to maintain oil prices at its target level by setting an upper production limit among its members.



Among its members, only Saudi Arabia has, at present, significant spare production capacity. They have the potential to increase their production capacity by up to 1 million barrels per day. As a result of supply not catching up to demand, the stock (inventory) of crude oil has significantly decreased and instabilities in the Middle East, Nigeria, and Venezuela, as well as, natural disasters, have all contributed to fears of supply disruptions and higher prices. While the US does not import oil from Iran, they are a major player in the global oil market since other countries including Russia, China, and some European countries buy from them.


Table 2 shows a breakdown of the exporters of oil to the US market. In contrast to Canada and Mexico, both of which rely almost entirely on the US for buying their oil, only 15% of Saudi oil is exported to the US. Nevertheless, it is these OPEC producers that have the greatest influence on the world oil market.







Table 2. Major contributors to U.S. imports of oil in order of quantity.[2]




In his recent article The First Law Of Petro-Politics,[3] New York Times columnist Thomas Friedman describes the current war on terrorism as one in which the Americans fund both sides of the war. While paying for our own military expenses, the US purchases energy from unstable regimes that harbor terrorists. Americans are essentially funding countries that harbor enmity towards the US, as well as our own military. He notes that for these petrolist states, there is a direct correlation between the price of oil and the degree of democracy: When oil prices are low, these regimes are under pressure to open up and democratize. Conversely, when oil prices are high as they are today, these governments will clamp down on dissent or “buy off their opponents.” This authoritarian-like behavior consequently leads to anti-American activities.




What is the impact of the oil price on the U.S. economy?


Figure 2 shows a juxtaposition of the normal price of crude with the price adjusted for inflation. Higher fuel prices have generally led to higher inflation throughout the economy. The spike in the price of a barrel of oil in 1980, which exceeded $90 in 2005 dollars, led to an inflation rate of over 13.5%. As all industries depend on energy, this experience shows the vulnerability of the US economy to price fluctuations in the oil market.







Figure 2. Crude prices adjusted for 2005 dollars and inflation rates.




How is gasoline produced?


To help the public come to grips with the true costs of our fossil-fuel dependence - notably, where the money goes and who benefits - the major factors that influence the price of gasoline are described below.




The flow of gasoline follows three major steps: production, refining, and distribution. In addition, marketing, retailing, and taxes add to the cost. Figure 3 shows how each of these steps contributes to the overall price of gasoline.





 
Figure 3. Breakdown of gasoline prices (source: Department of Energy)




In 2004, the price of crude contributed to 47% of the overall price of a gallon of gasoline at an average of $1.85 per gallon. According to ABC News[4] (April 2006), a higher crude price at $70 per barrel has changed the breakdown of the components of the price of gasoline. At $3.10 per gallon, crude accounts for more than a half of the cost of gasoline.




In the production step, crude oil is extracted from the ground and transported to refiners. The average global production cost – that is the cost of discovering and extracting a barrel of oil from the ground – is about $14.5 per barrel today for crude oil obtained from foreign countries. When broken down, these costs include $9.18 for discovery, $4.12 for extraction (well-head price), and $1.16 in taxes.[5] These values can vary dramatically between countries. For example, oil from the Middle East has been substantially less expensive to produce. In contrast, oil from Canada is costlier to extract because it is obtained from non-conventional sources like tar sands, which requires a more intensive process for extraction.




Who profits from each phase?


Big oil companies (eg. Exxon-Mobil, Shell) make money at every step of the process because they take the oil out of the ground, refine it and sell it. Exxon-Mobil's profit is estimated at a hefty 29 percent.[6]




The production phase is by far the most profitable part of gasoline. The profit is essentially the difference between the market price of crude oil minus its production costs. Assuming crude oil sells for $70 per barrel, each barrel would yield about $55.50 of profit. The profit goes to the entity that holds the rights to these reserves. Today, the producer generally refers to the country from which the oil is extracted. About 85% of foreign reserves are held by their governments or firms that are being nationalized. In another words, these production revenues will go directly to foreign regimes. US oil companies profit from production only by extracting from fields which they have rights to (mostly domestic).




Although the cost of production varies between countries, the selling price will be about the same because oil is part of the global oil market. The U.S. does not buy from Iran, but events there have an impact on world oil prices. Likewise, US oil use benefits Iran by increasing overall global demand.




In the refining phase, oil companies take the crude and separate the components in a process called “cracking.” From each barrel of crude, about 19.5 gallons of gasoline are produced. Improvements in the cracking process have helped to extract more gasoline from each barrel and also from lower quality grades of crude. This process currently adds an average of 55 cents to the cost of one gallon of gasoline. Refining costs are typically 40 to 45 cents with about 10 cents in profit per gallon.




From the refinery, most gasoline is shipped first by pipeline to regional terminals where it is then loaded onto trucks for delivery to individual fueling stations. Some retail outlets are owned and operated by refiners, while others are independent businesses that purchase gasoline for resale to the public. The price on the pump reflects both the retailer’s purchase cost for the product and other costs associated with operating the service station. It also reflects local market conditions and factors, such as the desirability of the location and the marketing strategy of the owner.




 So is the price of crude oil the primary reason gasoline prices keep going up?


Figure 4 shows the impact of crude prices on the price of gasoline. Although refining costs have also fluctuated, the current rise in gasoline price is primarily due to the rise in crude.









Figure 4. Comparison of the national price average retail price of gasoline and the price of crude oil. (Source: Government Accountability Office)






What is driving crude prices up?


Until 2001, crude oil had maintained an average price of about $20 per barrel for several years, but has tripled over the last few years. According to the International Energy Agency (IEA), the increase in prices is primarily due to worldwide economic expansion rather than the events of 9/11. Figure 5 shows how global demand is increasing. However, another factor might be termed the terror premium, which is based on the fear that terrorist activities contribute to the uncertainty in future oil supplies. Analysts have pegged this fear factor at about $10.









Figure 5. Global demand for oil. (Source: Government Accountability Office)




The increasing demand is primarily attributed to the US, China, and other developing Asian countries, which have continued to increase their importation of foreign oil in spite of higher prices. Between 2002 and 2003, China alone increased their consumption of gasoline by 30%. In the US, the demand is driven partly by the purchase and use of highly inefficient sports utility vehicles (SUVs) that comprise a growing percentage of vehicles driven on the road. In contrast to some automobiles that have efficiency ratings of over 40 mpg, these gas guzzlers’ do not exceed 15 mpg. Figure 6 shows the U.S. contribution to the global increase in oil demand.







Figure 6. U.S. demand for oil. (Source: Government Accountability Office)




What is the impact of 9/11?


Until September 11, 2001, crude price averaged over the previous five years was $19 per barrel. Figure 7 shows the price of crude did not increase immediately after the events of 9/11, dispelling a direct correlation between that event and increased oil prices. In fact, prices had gone down for several months after the event, but since then they have steadily risen to today’s level of $70 per barrel.









Figure 7. Price of crude for the United States and critical events in the War on Terror.




Perhaps the more relevant question is what is the impact of the war in Iraq? In the lead-up to the current engagement in Iraq from December 2002 to March 2003, the cost of crude went up $10. Some analysts have ascribed this as the terror premium,[7] though other estimates range between $5 and $15.




Who has profited the most since 9/11 and the War in Iraq?


The rise in the price of crude has greatly benefited oil exporting nations, namely those in the Middle East, Nigeria, and Venezuela, which are among the largest oil suppliers in the world. These petrolist states, as described by Tom Friedman, are also the very same ones that would benefit from a terror premium, given the control they have over the reserves. Although Canada and Mexico are the largest suppliers to the U.S., they are not countries that face major instabilities in their governments. Moreover, in spite of worldwide price increases, their profit margins are smaller than OPEC members’ because their crude is of lower grade or comes from non-conventional sources (e.g., tar sands) that cost more to produce.




Figure 8 shows the jump in profits for various countries since the beginning of the Iraq conflict. For the base case (pre-9/11 average price of $19 per barrel), a profit margin of $4.5 per barrel was assumed ($3.50 for African countries due to higher production costs). [8]







Figure 8. Comparison of cumulative profits at pre-9/11 average ($19 per barrel) and actual profits since the beginning of the military action in Iraq (March 2003) for oil that has been purchased by the US and internationally.



By aggregate profit, Saudi Arabia appears to have benefited the most from the rise of crude prices. From the US alone, nearly $40 billion in extra wealth has been transferred since the beginning of conflict in Iraq. Internationally, the Sauds have gained $200 billion in this time period.



While it would be difficult to monetize the terror premium from the other uncertainties that underlie the current price of crude, one can assume $10 per barrel based on the pre-war run-up described above.  Table 9 shows how much the US and the world have potentially paid for the war factor.





Figure 9. Cumulative terror premium since the beginning of the military action in Iraq (March 2003) for oil that has been purchased by the US and internationally. Assumes $10 per barrel premium.



Based on the presumed threat of terrorism, each member of OPEC has profited generously. Between the start of the Iraq war and the present, the US has transferred approximately $15 billion in wealth to Saudi Arabia on this factor alone. Internationally, the Sauds have gained over $100 billion. Each month, the terror premium costs the US $2.4 billion based on 8 million barrels that are imported each day (all sources) using the $10 per barrel figure.

 
What is the cost of our military involvement in the Middle East?

Instead of promoting democracy and opening markets, oil rich nations in the Middle East and Nigeria have tended to enrich their elite, creating social instability and fomenting terrorist activities, which the US must ultimately pay through military and diplomatic presence. Before the current military campaigns in Afghanistan and Iraq were undertaken, it has been estimated that the military presence (namely, the US 6th Fleet) needed to maintain an uninterruptible supply of crude cost the US up to $70 billion per year or about $10 per barrel.



The current military action in Afghanistan and Iraq adds at least another $80 billion per year or about $11 per barrel[9] for “insurance” costs that are hidden from “gasoline” consumers but paid for by tax dollars.





Table 3. Military costs for War on Terror.




What is the appropriate tax for gasoline?

In a recent New York Times poll, readers were asked for their views on a gasoline tax. Over 50% of Americans favored a gasoline tax if it would make America independent of the worst regimes around the world. Moreover, nearly 60% supported a tax if it could be used to combat climate change.



Many experts believe a carbon emissions tax is needed to transform the current combustion engine/fossil fuel economy to one that is energy independent and reduces greenhouse gas emissions. These revenues could be used to develop alternative sources of energy and technologies to improve mileage. To put into perspective how much gasoline costs relative to an effective carbon tax needed to address climate change, we assume a figure of $35 per ton of carbon dioxide (CO2) emissions. At 20 pounds of emissions per gallon of gasoline consumed, this is equivalent to nearly $0.32 of carbon tax per gallon.[1]



With today’s average price of gasoline at $3.10 per gallon the suggested carbon tax would equate to a 10% “at-the-pump” price increase. There is much debate as to who – consumers or oil companies – should pay for such a tax, but with extremely high profit margins for crude production, a carbon tax would put only a small dent in the profit of oil producers.  Alternatively, if consumers bear the cost, they could be compensated through a reduction in other taxes or through incentives to purchase fuel-efficient vehicles. Most experts feel a tax such as this would start to change consumer behavior and “redirect” the economy without harming it.





How does our dependence on foreign oil affect the US trade deficit and the loss of jobs?

Today, one-third of the annual US trade deficit is spent on oil imports. In November 2005 alone, this amounted to $24 billion.[2] According to the latest trade figures, the US is projected to buy an unprecedented $320 billion worth of crude from abroad in 2006.[3]



The Department of Energy estimates that for every $1 billion in deficit spending, 27,000 jobs are lost in America.[4] Based on current deficit figures, this means we could have added up to 8.6 million American jobs this year. For example, instead of buying the oil from abroad, jobs could be created by domestically fostering an ethanol fuel industry.



Have big oil companies profiteered from today’s oil market?

For the industry, the market caps (value of the company) of the largest oil companies BP, ExxonMobil, Shell, and Chevron, as well as industry service providers like Halliburton and Schlumberger have at least doubled since 9/11. The increase in their stock prices has roughly coincided with the rise in oil prices.



The record windfall earnings of oil companies have raised concerns of profiteering.  However, these companies state that their profits are the result of the rise in crude prices for oil that they themselves produce and from efficiency gains in the refining process. Furthermore, since the oil they produce is part of the global oil market it fetches the same price as does oil worldwide. As an example of efficiency gains, over the past five years, ExxonMobil has cut its workforce by one-fifth while its return on capital has increased by 20%.[5]



Nevertheless, there have been claims that the industry is deliberately constraining refining capacity in order to create a shortage to boost the price of gasoline. Although the technology for oil refining has continued to improve (e.g., more gasoline can be recovered from lower grade crude) the supply of gasoline has not been able to keep up with growing demand. For various reasons, including high capital costs and more stringent environmental regulations, new oil refineries have not been built since 1976 in the US despite increasing pressure to do so.



At this point, there is no evidence that the industry is engaging in price gouging by artificially limiting their refining capacity. In 2006 alone, oil companies and investors are spending a collective $100 billion on new oil refineries.[6] However, no refineries will be built in the US because of opposition from communities where sites have been proposed. About 60 percent of them will be constructed in the Middle East and in Asia.



How much tax breaks are oil companies getting?

According to the Government Accountability Office (GAO), big oil is getting at least $20 billion in annual tax breaks.[7] These contribute to another $3 per barrel in hidden fees. Some of these breaks include depletion allowances, production credits, exploration and development costs. In addition there are also foreign tax credits and state sales tax are usually lower when compared to other industries.





How much in federal subsidies are oil companies getting?

Approximately $0.32 per gallon in fuel taxes are dedicated to maintain the transportation infrastructure.[8] However these taxes and toll fees collected are not enough to cover the cost to constructing and maintaining roadways. As much as $112 billion in government funds are needed to finance highway projects each year.[9] This amounts to another $15 per barrel in hidden costs.





What are the health costs of motor transportation?

Although continued improvements in lowering emissions from motor vehicles have helped to make the air cleaner by reducing particulate matter into the air, there are still noxious gases including nitrous oxide and ozone that contribute to a lower quality of health.



In addition, allergy and asthma symptoms are exacerbated by global warming effects, which are directly linked to the burning of fossil fuels like gasoline. The medical spending and associated losses from productivity due to these respiratory illnesses are estimated to be between $30 and $530 billion per year.[10]

The US spends approximately $2 trillion for health care each year. Assuming an average of 10% or $200 billion that these illnesses cost in medical fees, this adds another $26 in unseen costs per barrel of oil. In addition, lost wages of the same magnitude can be expected. For our calculations, health related costs are pegged in the range of $26 to $52 per barrel of crude.





What about environmental losses?

The pollution from the oil industry will cost hundreds of billions. While quantifying the impact of the urban car culture on the environment is somewhat arbitrary, several researchers have already done extensive work. Table 4 shows a breakdown of the sources of environment related losses that are associated with the consumption of gasoline.[11]



 

Table 4. Environmentally associated costs with gasoline usage (Source: International Center for Technology Assessment).



Because of the subjective nature of these figures, we assume a range of values between $150 billion and $300 billion per year in environmental costs or approximately $20 to $40 per barrel in hidden costs.  Despite these already enormous costs, they do not take into account the losses associated with global warming.





Adjusted price of gasoline


When subsidies, tax breaks, military, health, and environmental costs are accounted for, each barrel of crude essentially costs between $168 and $214 per barrel. At today’s average cost of gasoline at $3.10 per gallon, taxes and refining and distribution costs add up to about $60 per barrel. When these are added to the adjusted cost of crude, each gallon of gasoline costs between $5.48 and $6.55 per gallon.






[1] When hydrocarbons, CxHy, are burned off, they combine with oxygen gas, O2, to form carbon dioxide gas, CO2, and water:


CxHy + O2 ® H2O + CO2


In each gallon of gasoline there is approximately 5.3 pounds of carbon in the hydrocarbon molecules. Carbon has a weight of 12 while carbon dioxide is 44. When a gallon of gasoline is combusted, it produces 5.3 x (44/12) = 20 pounds of carbon dioxide. [2] http://www.energybulletin.net/14131.html


[3] http://lugar.senate.gov/pressapp/record.cfm?id=253296


[4] http://www1.eere.energy.gov/biomass/economic_growth.html


[5] http://news.bbc.co.uk/1/hi/business/4713186.stm


[6] http://washingtontimes.com/business/20060528-110421-6935r.htm


[7] http://select.nytimes.com/gst/abstract.html?res=F30615FF3E540C7A8EDDAA0894DE404482


[8] 1997 Facts and Figures, Motor Vehicle Manufactures Association, p. 67.


[9] Litman et. al. (high estimate)[10]


U.S. Environmental Protection Agency, Our Built and Natural Environments: A Technical Review of the Interactions between Land Use, Transportation and Environmental Quality, Development Community and Environmental Division, EPA 231-R-01-002, Washington, DC, January 2001, www.epa.gov/piedpage/pdf/built.pdf


[11] International Center for Technology Assessment, The Real Price of Gasoline: Report No. 3, An Analysis of the Hidden Eternal Costs Consumers Pay to Fuel Their Automobiles, Washington, DC, November 1998.




Frank H. Ling1,3 and Daniel M. Kammen1,2,3*
1Energy and Resources Group, 2Goldman School of Public Policy
3Renewable and Appropriate Energy Laboratory
University of California, Berkeley




Click here for a printable version.

Read/Post Comments (0)







Comments (0)

There are currently no comments for this editorial...
To post your own comment, use the form to the right. Thanks.

Post a Comment

Your Name


State (Optional)


Comments


Please enter the numbers you see into the field below