Before the oil runs out: How US can cope when gas prices surge

Gasoline prices set a new record earlier this month in the wake of hurricane Katrina, but costs were already rising fast before the superstorm collided with the Gulf Coast.

The average price of regular gasoline has more than doubled since 2002, when it stood at just $1.36 a gallon. Since reaching $3.01 earlier this month, topping the 1981 high of $3.00 (adjusted for inflation), consumers are worried. Will this four-year price spiral stop? Or could we be headed for $5 gas?

Right now, prices are falling as the summer driving season ends and Gulf Coast refineries return to service. Yet the long-term outlook appears shaky. That's because the future price of oil, which hinges on everything from OPEC policies to Chinese energy demands, could easily keep going up.

But there are at least four areas where oil-importing nations can dampen the effects of a rise in oil prices. The United States has fallen short in anticipating all four, energy experts say. For example:

Refining capacity. "Oil companies want to make money with refineries, and they did not want to get excess capacity by over-investing," says Lehi German, president of Fundamental Petroleum Trends, a weekly newsletter. Oil companies felt that if America suddenly needed more gasoline or diesel fuel, "then import it."

So today, even if the Saudis and their oil allies filled up 1,000 tankers and sent them steaming to the US, it's not clear that gas prices would fall very much.

The problem is twofold: US refiners' lack of capacity to handle the extra load, as well as technical problems with the types of heavy crude produced in much of the Middle East.

US firms are expected to rectify these shortcomings, but it will take years. Meanwhile, supplies of refined product are so tight that the US is now importing gasoline, not just oil, from Canada and Europe.

Government policy. Back in the 1970s energy crisis, which included an OPEC oil embargo, Congress got tough with actions that included creation of the Strategic Petroleum Reserve, minimum gas-mileage requirements for cars and trucks (CAFE standards), and "double nickel" (55 mile-per-hour) speed limits.

By comparison, this Congress and president took less decisive measures. They have subsidized alternative energy and passed an energy bill this year. The White House has proposed raising CAFE standards slightly. But it was too little and too late to head off the price spike. Both branches of the federal government could become more active if prices keep moving up.

Auto efficiency. The nation's Big Three automakers - General Motors, Ford, and DaimlerChrysler - have made the bulk of their profits in recent years with large and not particularly fuel-efficient trucks and SUVs. Very often, technical improvements to engines, which could have been used to boost gas mileage, went instead to increase horsepower and speed.

There were exceptions to the trend, especially among Japanese automakers Toyota and Honda. Both developed hybrid-model cars (the most popular of which is the Toyota Prius) that combine gasoline and electric engines to increase mileage into the 47-to-66 miles-per-gallon range.

Detroit is now stepping up efforts to get hybrids on the road, including the Ford Escape SUV hybrid, which has proved popular. But if prices for fuel stay high, Detroit will have once again come in second in an important new market that Japan managed to exploit.

Energy planners. Both government and private officials didn't foresee the current oil squeeze. So they didn't promote policies to encourage construction of new refineries, foster training of more oil-field experts, and reverse a recent decline in the fuel mileage of America's auto and truck fleet.

An oil industry specialist, speaking on background, notes that during the 1980s, when activity in US oil fields went into sharp decline, as many as 1 million people, many with valuable knowledge, were let go by the oil industry. Even now, Americans seeking advanced degrees in skills valuable to the industry are few and far between.

With specialists again in demand in US oil fields, some major companies are having trouble getting geologists and petroleum engineers.

The most crucial factor affecting gas prices, of course, is the price of oil. And OPEC, the Organization of Petroleum Exporting Countries, is doing little to meet rising demand.

Thirty years ago, this oil-producing cartel of 11 nations, led by Saudi Arabia, had the ability to produce about 30 million barrels of crude per day. Today, they have the capacity to produce about ... 30 million barrels per day (b.p.d.). "So far, they are not really doing anything," says Ed Porter, research manager for policy analysis at the American Petroleum Institute.

There's a risk in this tight-market strategy by OPEC. In the early 1980s, during the second oil crisis when gas shortages rippled across the US, prices went up swiftly. As a result, many companies and individuals sought other sources of energy, such as natural gas and coal. Eventually, OPEC lost crude oil sales of 10 million b.p.d. because prices went too high.

Tuesday, in an effort to calm markets and dampen price speculation by traders, OPEC agreed to make available an extra 2 million barrels of oil a day for the next three months. But cartel officials insist that current prices are too high and worry about an oil glut next spring. "That's the period we have to watch," warns Edmund Daukoru, Nigeria's oil minister.

One big reason for the price surge: China, whose booming economy has generated huge demand internally for new automobiles despite having to import much of its fuel supplies. China has also suffered from a lack of electricity because of a slowdown in construction of new power plants during the Asian fiscal crisis of 1998-2002, according to an economist with the Chinese Embassy in Washington. When the economy took off again in 2003 and 2004, brownouts and blackouts hit the nation. To keep factories going at full speed, companies installed diesel generators, which helped boost oil use by 16 percent last year. Those effects still linger.

China is one of two wild cards that could send oil prices soaring or bring them under control. It accounted for 40 percent of total growth in world energy demand from 2000 to 2004, according to Cambridge Energy Research Associates (CERA). If that continues, it will have a "heavy long-term impact" on prices, says a recent report by the energy advisory firm based in Cambridge, Mass.

The other wild card is OPEC. In a report this summer, CERA predicted production will rise both in and out of OPEC through at least 2010. If so, that will be good news for the world's economies - and for all those SUV drivers.

Second of three articles. Thursday: The search for alternatives.

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