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[Senate Prints 109-64]
[From the U.S. Government Publishing Office]

109th Congress                                                      S. Prt.
 2d Session                 COMMITTEE PRINT                         109-64

===========================================================================
 
                     ENERGY DIPLOMACY AND SECURITY

                               __________

                            A COMPILATION OF

                        STATEMENTS BY WITNESSES

                               BEFORE THE

                     COMMITTEE ON FOREIGN RELATIONS

                          UNITED STATES SENATE

                       One Hundred Ninth Congress

                             Second Session

                               June 2006

                                     

       Printed for the use of the Committee on Foreign Relations

   Available via World Wide Web: http://www.gpoaccess.gov/congress/
                               index.html

                                 _____

                     U.S. GOVERNMENT PRINTING OFFICE
                             WASHINGTON: 2006        
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                     COMMITTEE ON FOREIGN RELATIONS

                  RICHARD G. LUGAR, Indiana, Chairman

CHUCK HAGEL, Nebraska                JOSEPH R. BIDEN, Jr., Delaware
LINCOLN CHAFEE, Rhode Island         PAUL S. SARBANES, Maryland
GEORGE ALLEN, Virginia               CHRISTOPHER J. DODD, Connecticut
NORM COLEMAN, Minnesota              JOHN F. KERRY, Massachusetts
GEORGE V. VOINOVICH, Ohio            RUSSELL D. FEINGOLD, Wisconsin
LAMAR ALEXANDER, Tennessee           BARBARA BOXER, California
JOHN E. SUNUNU, New Hampshire        BILL NELSON, Florida
LISA MURKOWSKI, Alaska               BARACK OBAMA, Illinois
MEL MARTINEZ, Florida
                 Kenneth A. Myers, Jr., Staff Director
              Antony J. Blinken, Democratic Staff Director

                                  (ii)

                            C O N T E N T S

                              ----------                              

                                                                   Page
Letter of Introduction...........................................     v

``U.S. Energy Security--A New Realism'' speech delivered by Hon. 
  Richard G. Lugar on March 13, 2006, at the Brookings 
  Institution....................................................   vii

                              June 7, 2006

Hon. Richard G. Lugar, U.S. Senator from Indiana, Chairman, U.S. 
  Senate Committee on Foreign Relations..........................     1

Hon. Joseph R. Biden, Jr., U.S. Senator from Delaware, Ranking 
  Member, U.S. Senate Committee on Foreign Relations.............     3

Hon. Alan Greenspan, President, Greenspan Associates LLC, 
  Washington, DC.................................................     6

                              May 16, 2006

Hon. Richard G. Lugar, U.S. Senator from Indiana, Chairman, U.S. 
  Senate Committee on Foreign Relations..........................    11

Hon. Joseph R. Biden, Jr., U.S. Senator from Delaware, Ranking 
  Member, U.S. Senate Committee on Foreign Relations.............    13

Vinod Khosla, Partner, Khosla Ventures, Menlo Park, CA...........    15

Jason S. Grumet, Executive Director, National Commission on 
  Energy Policy, Washington, DC..................................    23

                             March 30, 2006

Hon. Richard G. Lugar, U.S. Senator from Indiana, Chairman, U.S. 
  Senate Committee on Foreign Relations..........................    41

Hon. Joseph R. Biden, Jr., U.S. Senator from Delaware, Ranking 
  Member, U.S. Senate Committee on Foreign Relations.............    44

Milton R. Copulos, President, National Defense Council 
  Foundation, Alexandria, VA.....................................    46

Dr. Hillard Huntington, Executive Director, Energy Modeling 
  Forum, Stanford University, Stanford, CA.......................    53

Dr. Gary W. Yohe, John E. Andrus Professor of Economics, Wesleyan 
  University, Middletown, CT.....................................    57

                           November 30, 2005

Hon. Richard G. Lugar, U.S. Senator from Indiana, Chairman, U.S. 
  Senate Committee on Foreign Relations..........................    63

Hon. James Schlesinger, Senior Advisor, Lehman Brothers, 
  Washington, DC.................................................    66

Hon. R. James Woolsey, Vice President, Booz Allen Hamilton, 
  McClean, VA....................................................    70

                                 (iii)

                         LETTER OF INTRODUCTION

                              ----------                              

                                                      June 8, 2006.
    Dear Colleague: The Committee on Foreign Relations is 
continuing to hold a series of hearings examining the 
geopolitical consequences of global energy imbalances and U.S. 
dependence on energy imports. Given the growing importance of 
energy security in our foreign policy today and the prominence 
of energy in our ongoing policy debates, I believe it is 
important that these analyses be made available to the entire 
Senate.
    The current United States energy portfolio, and in 
particular our dependence on foreign oil, has widespread and 
dramatic impacts on our national security. On March 13, 2006, 
in a speech at the Brookings Institution, I outlined the scope 
of the challenge before us, including myriad threats to our 
national security and economic prosperity. Over the past few 
months, the Committee held several hearings focusing on these 
threats caused by our current dependence on oil.
    The Honorable Alan Greenspan, former Chairman of the 
Federal Reserve, testified on the subject of ``Oil Dependence 
and Economic Risk'' at a hearing on June 7, 2006, including the 
vulnerabilities of the current global oil market and the need 
for reducing the dominance of oil in our energy portfolio.
    On May 16, 2006, the Committee examined strategies to 
reduce our oil dependence at a hearing on ``Energy Security and 
Oil Dependence.'' Mr. Vinod Khosla, Partner of Khosla 
Associates, and Mr. Jason Grumet, Executive Director of the 
National Commission on Energy Policy offered testimony.
    A hearing on March 30, 2006, entitled ``Hidden Costs of 
Oil'' focused on understanding the full range of economic costs 
associated with U.S. oil dependence. Testimony was heard from 
Mr. Milton Copulos, President of the National Defense Council 
Foundation, Dr. Hillard Huntington, Executive Director of the 
Energy Modeling Forum at Stanford University, and Dr. Gary 
Yohe, John E. Andrus Professor of Economics at Wesleyan 
University.
    On November 16, 2005, The Honorable James Schlesinger, 
former Secretary of Defense, Secretary of Energy, and Director 
of Central Intelligence, and The Honorable R. James Woolsey, 
former Director of Central Intelligence, gave testimony on the 
severity of the challenges posed by energy security at a 
hearing entitled ``High Costs of Crude: The New Currency of 
Foreign Policy.''
    I believe that the information contained in this print can 
be helpful in preparing Members for subsequent Senate debate on 
this issue of vital national security interest.
            Sincerely,
                                Richard G. Lugar, Chairman,
                             Senate Committee on Foreign Relations.
  U.S. Senate Foreign Relations Committee Chairman, Richard G. Lugar, 
 addressed the Brookings Institution, March 13, 2006, on ``U.S. Energy 
                       Security--A New Realism.''

                              ----------                              

    It is a privilege to deliver the inaugural speech for the 
Brookings Institution's 90th Anniversary Leadership Forum 
series. I have had the opportunity to come here to share my 
thoughts on a number of national security issues over the 
years, and your reception has always been generous. I 
appreciate very much receiving the invitation to speak from my 
good friend, Strobe Talbott, who has been a source of sound 
counsel for many years and who continues to provide outstanding 
national and international leadership.
    Last August, I represented President Bush on a diplomatic 
mission to North Africa. The President asked me to go to 
Algeria and Morocco to facilitate the release of the longest-
held prisoners of war in the world--404 Moroccan soldiers, some 
of whom had been held since the 1970s by the Polisario Front 
operating out of Algeria. American diplomats had discussed 
their potential release, and General Jim Jones, Supreme Allied 
Commander Europe, had offered to transport the POWS home to 
their families in Morocco. After this humanitarian mission had 
been fulfilled, I had the opportunity, with the 
Administration's blessing, to continue on to Libya for meetings 
with Libyan officials, including Muammar Qaddafi.
    While staying overnight in the Corinthia Hotel in Tripoli, 
overlooking the Mediterranean, I came face to face with a 
microcosm of the new reality of global economic life. It was 
impossible to walk around the hotel without meeting someone who 
was hoping to tap into Libya's oil reserves. The hotel was 
populated with representatives from China, India, and Western 
oil companies who were in Libya to stake out drilling or 
refining options for every pool of oil that the government 
might make available. The world had come to the Corinthia Hotel 
to compete for the energy opportunities that were expected to 
develop with Libya's hopeful return to the international 
mainstream.
    I relate this anecdote to underscore how rapidly the world 
is changing due to the expansion of energy demand. These 
conclaves of modern day oil prospectors can be found wherever 
there are proven energy supplies and a government willing to 
bargain. Indeed, my delegation also saw evidence of this in 
natural gas-rich Algeria. The Chinese and Indians, with one 
third of the world's people between them, know that their 
economic future is directly tied to finding sufficient energy 
resources to sustain their rapid economic growth. They are 
negotiating with anyone willing to sell them an energy 
lifeline.

                    the shifting balance of realism

    The gasoline price spikes following the Katrina and Rita 
hurricanes underscored for Americans the tenuousness of short-
term energy supplies. But, as yet, there is not a full 
appreciation of our economic vulnerability or the competition 
that is already occurring throughout the world.
    In a remarkable moment during the State of the Union 
Address, President Bush caught the attention of the nation with 
five words: ``America is addicted to oil.'' Those five words 
probably generated more media commentary than all the rest of 
his remarks from that evening combined. I had an opportunity 
soon after the speech to talk to the President about energy, 
and he admitted that he had not anticipated the impact of that 
statement or that some commentators would find it incongruous. 
I believe he is genuine in wanting to devote more focus to 
pursuing alternative energy sources. But his Texas roots, his 
administration's high-profile advocacy of opening up the Arctic 
National Wildlife Refuge to drilling, and other associations 
with the oil industry have created long-standing public 
impressions that the President is an oil-man who believes in 
the oil economy.
    Though not hostile to alternative energy sources, the Bush 
administration clearly downplayed their significance during the 
early part of his Presidency. Vice President Cheney, who 
oversaw Bush administration energy policy, stated on April 30, 
2001, ``Years down the road, alternative fuels may become a 
great deal more plentiful than they are today. But we are not 
yet in any position to stake our economy and our way of life on 
that possibility. For now, we must take the facts as they are. 
Whatever our hopes for developing alternative sources and for 
conserving energy--and that's part of our plan--the reality is 
that fossil fuels provide virtually 100 percent of our 
transportation needs and an overwhelming share of our 
electricity requirements. For years down the road, this will 
continue to be true.''
    For decades, the energy debate in this country has pitted 
so-called pro-oil realists against idealistic advocates of 
alternative energy. The pro-oil commentators have attempted to 
discredit alternatives by saying they make up a tiny share of 
energy consumed and that dependence on oil is a choice of the 
marketplace. They assert that our government can and should do 
little to change this. They have implied that those who have 
bemoaned oil dependency do not understand that every energy 
alternative comes with its own problems and limitations. Lee 
Raymond, the former CEO of Exxon offered an example of this 
line of reasoning in 2005: ``There are many alternative forms 
of energy that people talk about that may be interesting. But 
they are not consequential on the scale that will be needed, 
and they may never have a significant impact on the energy 
balance. To the extent that people focus too much on that--for 
example, on solar or wind . . .--what they are doing is 
diverting attention from the real issues. And 25 years from 
now, even with double-digit growth rates, they will still be 
less than 1 percent of the energy supplied to meet worldwide 
demand. I am more interested in staying focused on the 99 
percent than the 1 percent.''
    Indeed, advocates of alternative energy must resist the 
rhetorical temptations to suggest that energy problems are 
easily solved. They are not. Relieving our dependence on oil in 
any meaningful way is going to take much greater investments of 
time, money, and political will. There is no silver bullet 
solution. But the difficulty of solving the problem does not 
make it any less necessary. The President's State of the Union 
address indicates that he understands this.
    Whether or not one classifies America's oil dependence as 
an addiction, the bottom line is that with less than 5 percent 
of the world's population, the United States consumes 25 
percent of its oil. If oil prices remain at $60 a barrel 
through 2006, we will spend about $320 billion on oil imports 
this year. Most of the world's oil is concentrated in places 
that are either hostile to American interests or vulnerable to 
political upheaval and terrorism. And demand for oil will 
increase far more rapidly than we expected just a few years 
ago. Within 25 years, the world will need 50 percent more 
energy than it does now.
    With these basics in mind, my message is that the balance 
of realism has passed from those who argue on behalf of oil and 
a laissez faire energy policy that relies on market evolution, 
to those who recognize that in the absence of a major 
reorientation in the way we get our energy, life in America is 
going to be much more difficult in the coming decades. No one 
who cares about U.S. foreign policy, national security, and 
long-term economic growth can afford to ignore what is 
happening in Iran, Russia, Venezuela, or in the lobby of the 
Corinthia Hotel in Tripoli. No one who is honestly assessing 
the decline of American leverage around the world due to our 
energy dependence can fail to see that energy is the albatross 
of U.S. national security.
    We have entered a different energy era that requires a much 
different response than in past decades. What is needed is an 
urgent national campaign led by a succession of Presidents and 
Congresses who will ensure that American ingenuity and 
resources are fully committed to this problem.
    We could take our time if this were merely a matter of 
accomplishing an industrial conversion to more cost effective 
technologies. Unfortunately, U.S. dependence on fossil fuels 
and their growing scarcity worldwide have already created 
conditions that are threatening our security and prosperity and 
undermining international stability. In the absence of 
revolutionary changes in energy policy, we are risking multiple 
disasters for our country that will constrain living standards, 
undermine our foreign policy goals, and leave us highly 
vulnerable to the machinations of rogue states.
    The majority of oil and natural gas in the world is not 
controlled by those who respect market forces. Geology and 
politics have created petro-superpowers that nearly monopolize 
the world's oil supply. According to PFC Energy, foreign 
governments control up to 77 percent of the world's oil 
reserves through their national oil companies. These 
governments set prices through their investment and production 
decisions, and they have wide latitude to shut off the taps for 
political reasons.
    I am not suggesting that markets won't eventually come into 
play to move America away from its oil dependence. Eventually, 
because of scarcity, terrorist attacks, market shocks, and 
foreign manipulation, the high price of oil will lead to 
enormous investment in and political support for alternatives. 
Given enough time, overcoming oil dependence and imbalances is 
well within the scope of human, and indeed American, ingenuity. 
The problem is that such investment cannot happen overnight, 
and even if it did, it will take years or even decades to build 
supporting infrastructure and change behavior. In other words, 
by the time a sustained energy crisis fully motivates the 
market, we are likely to be well past the point where we can 
save ourselves. Our motivation will come too late and the 
resulting investment will come too slowly to prevent the severe 
economic and security consequences of our oil dependence. This 
is the very essence of a problem requiring government action.
    The first step is to admit how grave the problem is. 
Hopefully, we will look back on President Bush's declaration 
that America is ``addicted to oil'' as a seminal moment in 
American history, when a U.S President said something contrary 
to expectations and thereby stimulated change. Like President 
Nixon using his anticommunist credentials to open up China or 
President Johnson using his Southern roots to help pave the way 
for the Civil Rights Act, President Bush's standing as an oil 
man would lend special power to his advocacy, if he chose to 
initiate an all-out campaign for renewable energy sources.

                              six threats

    As a national security problem, energy is unique in that 
the risks we face from this single condition are diverse and 
are intensifying simultaneously. In fact, our energy dependence 
creates at least six different threats that could directly or 
indirectly undermine American security and prosperity. Each of 
these threats could be the subject of its own speech, but 
today, I will provide an abbreviated review.
    First, as we have seen, oil supplies are vulnerable to 
natural disasters, wars, and terrorist attacks that can disrupt 
the lifeblood of the international economy. The entire nation 
felt the spike in prices caused by Hurricanes Katrina and Rita 
last year. But these shocks, which helped send the price of oil 
to $70 a barrel, were minor compared to what would occur if 
major oil processing facilities in Saudi Arabia were sabotaged. 
In late February, terrorists attempted such an attack. They 
penetrated the outer defenses of Saudi Arabia's largest oil 
processing facility with car bombs before being repulsed. A 
successful terrorist attack--either through conventional ground 
assaults, suicide attacks with hijacked aircraft, terrorist 
inspired internal sabotage, or other means--would be 
devastating to the world economy. Al-Qaeda and other terrorist 
organizations have openly declared their intent to attack oil 
facilities to inflict pain on Western economies.
    Recently, we have also seen the shutdown of a fifth of 
Nigeria's production by militants, and Iraq's continuing 
struggle to expand its oil production capacity amidst terrorist 
attacks.
    The vulnerability of oil supplies is not a new concern. But 
the lack of spare oil production capacity is new. As recently 
as 4 years ago, spare production capacity exceeded world oil 
consumption by about 10 percent. As world demand for oil has 
rapidly increased in the last few years, spare capacity has 
declined to less than 2 percent. Thus, any major disruption of 
oil creates scarcity that will drive prices up.
    These circumstances require massive expenditures to 
preserve our oil lifeline. One conservative estimate puts U.S. 
oil-dedicated military expenditures in the Middle East at $50 
billion year.
    Second, over time, even if oil and natural gas supplies are 
not disrupted in dramatic ways that produce local or global 
economic shocks, worldwide reserves are nevertheless 
diminishing. This is occurring within the context of explosive 
economic growth in China, India, Brazil, and many other 
nations. The demand for energy from these industrializing 
giants is creating unprecedented competition for oil and 
natural gas.
    Americans paid 17 percent more for energy in 2005 than in 
the previous year. That increase accounted for 40 percent of 
the rise in the consumer price index. Last November, we spent 
more than $24 billion on oil imports, accounting for more than 
a third of our trade deficit.
    To meet world oil demand, the International Energy Agency 
estimates a need for $17 trillion in investment, with the bulk 
going to the Middle East. But political and economic conditions 
may not let this investment happen. Even if some investment 
does occur and reserves prove to be much larger than 
anticipated, there is no guarantee that hostile governments 
will either choose to develop new capacity or make any new oil 
available to the United States.
    In the decades to come, price will not be the only issue. 
We will face the prospect that the world's supply of oil may 
not be abundant and accessible enough to support continued 
economic growth in both the industrialized West and in large 
rapidly growing economies. As we approach the point where the 
world's oil-hungry economies are competing for insufficient 
supplies of energy, oil will become an even stronger magnet for 
conflict and threats of military action, than it already is.
    Third, the use of energy as an overt weapon by producing 
nations is not a theoretical threat of the future; it is 
happening now. Oil and natural gas are the currency through 
which energy-rich countries leverage their interests against 
import dependent nations such as ours. Iran has repeatedly 
threatened to cut off oil exports to selected nations if 
economic sanctions are imposed against it. Similarly Hugo 
Chavez in Venezuela has issued threats of an oil export embargo 
against the United States.
    In January, Ukrainians were confronted by a Russian threat 
to cut off natural gas exports in mid-winter if Ukraine did not 
submit to a four-fold price increase. Russia took action to 
deny some natural gas to Ukraine. The dispute led to sharp 
drops in gas supplies reaching European countries that depend 
on natural gas moving through Ukrainian pipelines from Russia. 
Russia charged that Ukraine was diverting gas intended for 
Austria, Italy, France, Hungary and other European nations. 
Eventually, the confrontation was resolved with a near doubling 
of the price of natural gas sold by Russia to Ukraine. In 
contrast, Russia did not inflict such a price increase on 
Belarus, considered by Moscow to be a good partner, compared to 
the pro-Western Ukrainian Government. The episode underscored 
the vulnerability of consumer nations to their energy 
suppliers.
    We are used to thinking in terms of conventional warfare 
between nations, but energy is becoming the weapon of choice 
for those who possess it. It may seem to be a less lethal 
weapon than military forces, but a natural gas shutdown to 
Ukraine in the middle of winter could cause death and economic 
loss on the scale of a military attack. Moreover, in such 
circumstances, nations would become desperate, increasing the 
chances of armed conflict and terrorism. The use of energy as a 
weapon might require NATO to review what alliance obligations 
would be in such cases.
    Fourth, even when energy is not used overtly as a weapon, 
energy imbalances are allowing regimes in countries that are 
rich in oil and natural gas to avoid democratic reforms and 
insulate themselves from international pressure and the 
aspirations of their own people.
    We are seeing Iran and Venezuela cultivate energy 
relationships with important nations that are in a position to 
block economic sanctions. For decades, we have watched Saudi 
Arabia and other gulf states use oil wealth to create domestic 
conditions that prevent movement toward democracy. In Russia 
and Nigeria, energy assets have offered opportunities for 
corruption. In many oil rich nations, oil wealth has done 
little for the people, while ensuring less reform, less 
democracy, fewer free market activities, and more enrichment of 
elites.
    Beyond the internal costs to these nations, we should 
recognize that we are transferring hundreds of billions of 
dollars each year to some of the least accountable regimes in 
the world. Some are using this money to invest abroad in 
terrorism, instability, or demagogic appeals to populism.
    At a time when the international community is attempting to 
persuade Iran to live up to its nonproliferation obligations, 
our economic leverage on that country has declined due to its 
burgeoning oil revenues. If one tracks the arc of Iran's 
behavior over the last decade, its suppression of dissent, its 
support for terrorists, and its conflict with the West have 
increased in conjunction with its oil revenues, which soared by 
30 percent in 2005.
    Sometimes observers comfort themselves with the thought 
that most U.S. imports come from friendly nations such as 
Canada and Mexico, rather than from Iran or other problematic 
countries. But oil is a globally priced commodity. Even if our 
dollars are not going directly to Iran, this does not mean that 
our staggering consumption of oil is not contributing to the 
price paid to Iran by other consumers.
    Fifth, the threat of climate change has been made worse by 
inefficient and unclean use of nonrenewable energy. In the long 
run this could bring drought, famine, disease, and mass 
migration, all of which could lead to conflict and instability.
    There are no unilateral solutions to climate change. I have 
urged the Bush administration and my colleagues in Congress to 
return to a leadership role on the issue of climate change. I 
have advocated that the United States must be open to 
multilateral forums that attempt to achieve global solutions to 
the problem of greenhouse gases.
    Our scientific understanding of climate change has advanced 
significantly. We have better computer models, more 
measurements, and more evidence--from the shrinking polar caps 
to expanding tropical disease zones for plants and humans--that 
the problem is real and is caused by man-made emissions of 
greenhouse gases, including carbon dioxide from fossil fuels.
    Sixth, our efforts to stem terrorist recruitment and 
prevent terrorist cells and training grounds in the developing 
world are being undercut by the high costs of energy. The 
economic impact of high oil prices is far more burdensome in 
developing countries than in the developed world. Generally, 
developing countries are more dependent on imported oil, their 
industries are more energy intensive, and they use energy less 
efficiently.
    The United Nations Conference on Trade and Development 
estimates that non-OPEC developing nations spend 3.5 percent of 
their GDP or more on imported oil--roughly twice the percentage 
paid in the main OECD countries. World Bank research shows that 
a sustained oil-price increase of $10 per barrel will reduce 
GDP by an average of 1.47 percent in countries with a per-
capita income of less than $300. Some of these countries would 
lose as much as 4 percent of GDP. This compares to an average 
loss of less than one half of one percent of GDP in OECD 
countries. Some nations, such as Nepal and the Democratic 
Republic of the Congo, would experience GDP losses from a 
sustained $10 increase in the price of a barrel of oil that are 
twice the amount of foreign assistance that they receive from 
the United States. Even a nation like Ethiopia, which receives 
the substantial sum of $134 million in U.S. assistance because 
it is a focus country of the President's AIDs initiative, would 
see almost all of this offset by a $10 oil price increase.
    Last week I chaired a Senate Foreign Relations Committee 
hearing on the nomination of Randy Tobias to be the new 
Administrator for USAID. In this capacity he would oversee a 
large share of our foreign assistance budget, which now exceeds 
$20 billion per year. This budget is intended to meet our 
humanitarian goals, but its success is also directly linked to 
national security. But all of this effort and money, in 
essence, can be wiped out merely by an increase in the price of 
energy.
    Without a diversification of energy supplies that 
emphasizes environmentally friendly energy sources that are 
abundant in most developing countries, the national incomes of 
energy poor nations will remain depressed, with negative 
consequences for stability, development, disease eradication, 
and terrorism.
    Each of these six threats from energy dependence is 
becoming more acute as time passes. Any of them could be the 
source of catastrophe. Any realistic American foreign policy 
must redeploy diplomatic, military, scientific, and economic 
resources toward solving the energy problem.
    The basic dilemma for U.S. energy policy is how can our 
Government speed up the transition to alternative renewable 
energy sources so that we can prevent irreparable harm to our 
nation or the world associated with these threats? The realist 
must ask: How can we shape our energy future before it shapes 
us in disastrous ways?

                     working toward energy security

    American energy policy to date has suffered from two 
fundamental flaws. First, we have let two decades of relatively 
cheap oil and natural gas deepen our dependence on imports. An 
approach that focuses on research, while ignoring deployment of 
new fuels will not meet our national security challenge.
    The second flaw is that we have lacked a truly 
comprehensive energy policy with energy security as a strategic 
goal. American energy policy has been focused on a narrow 
definition of energy security that strived to ensure sufficient 
supplies at affordable prices. This has translated into 
policies promoting diversification in supplies of oil and 
natural gas, with little emphasis on energy alternatives. A 
policy that relies on a finite resource concentrated in a few 
countries is doomed to failure. Our long-term security and 
prosperity require sufficient, affordable, clean, reliable, and 
sustainable energy.
    A first component of energy security is to ensure 
sufficient supplies. Our energy intensity per unit of GDP has 
steadily decreased, but our energy consumption is still 
projected to increase by more than a third over the next 25 
years. This demand scenario is not inevitable. Public policy 
can do more to promote efficiency while still growing the 
economy. Expanded programs to enhance energy efficiency in 
appliances, building construction, and industry are all 
necessary to keep our energy intensity declining.
    One third of our projected energy growth is in oil, a 
majority of which we have to import. I have cosponsored a 
bipartisan bill with Senators Bayh and Lieberman that would 
require federal agencies to implement a plan to reduce U.S. oil 
consumption by 10 million barrels a day by 2031. The 
legislation contains many provisions to enhance energy 
conservation--from tire efficiency to reduced school bus idling 
to light-weight materials research.
    Automakers have a central role to play in improving our oil 
efficiency. We are working to close the SUV CAFE standards 
loophole, and to get more hybrids and flex-fuel vehicles on the 
road. A fleet of hybrid, and future plug-in hybrids, that run 
on E-85 could reduce our oil use by 10 million barrels a day. 
The bill I have cosponsored removes the cap on the number of 
tax rebates for hybrid vehicles. It also fosters demand by 
requiring that 30 percent of the government auto fleet be 
hybrids and advanced diesels. With increased demand for fuel 
efficient cars, new manufacturing facilities will be built that 
provide jobs for Americans.
    In partnership with the American auto industry, we should 
provide a set of incentives that give them the opportunity to 
regain their strength and save jobs through innovation. This 
bill offers a 35-percent tax credit for automakers to retool 
their factories so that they can make fuel efficient, advanced 
technology vehicles.
    Affordability of energy supplies also remains a key goal 
for energy security. Crude oil still hovers around $60 a 
barrel, and last October's price for natural gas was more than 
double what it had been in the previous year. These high energy 
prices increase inflation and inhibit future economic growth.
    Elevated oil and natural gas prices do have the benefit of 
making alternative fuels more competitive. With the end of 20 
years of low oil and gas prices, investment in alternative 
fuels has surged. As more is invested, innovation in technology 
and production will drive prices down further. That is why it 
is so important to get the first cellulosic ethanol facilities 
up and running. The President said in his State of the Union 
Address that he wanted to make cellulosic ethanol ``practical 
and competitive within 6 years.'' In fact, one plant is ready 
to be built in Idaho, and many others could be built within the 
6-year timeframe. I have asked the President to make sure that 
the loan guarantees that Congress authorized for cellulosic 
ethanol production are in place by this summer.
    As alternative fuels become more competitive, oil and gas 
producers have strong incentive to drop prices to kill the 
competition. Investors need to know that alternative energy 
initiatives will continue to be competitive. A revenue-neutral 
$35 per barrel price floor on oil would provide the security 
investors need. At this price, alternative fuels like 
cellulosic ethanol, shale and tar sands oil, and Fischer-
Tropsch diesel could still compete with regular gasoline. Many 
analysts say that expensive oil is here to stay, but most 
energy investors are hesitant to take on that risk. A modest 
price floor for oil that we may never reach would provide a 
major stimulation for energy alternatives.
    Long-term energy security also requires the use of clean 
energy, a third component of energy security. As long as we 
continue to consume fuels that do not burn cleanly or cannot 
have their damaging gases sequestered, we will continue to pay 
environmental costs and will remain vulnerable to a climate 
change induced disaster.
    The Congress must pass legislation establishing a cap and 
trade mechanism. A cap and trade system would provide 
regulatory certainty, reward innovation to improve energy 
efficiency, and provide strong market incentives for clean 
renewable fuels. Any such system should give credit for carbon 
sequestration in coal-fired plants and allow farmers and 
foresters to sell credits for the carbon they sequester.
    I have introduced a resolution that calls for America to 
lead other nations to new agreements under the United Nations 
Framework Convention on Climate Change. Thanks to new 
technology, we can control many greenhouse gases with 
proactive, progrowth solutions, not just draconian limitations 
on economic activity. Industry and government alike recognize 
that progress on climate change can go hand in hand with 
progress on energy security, air pollution, and technology 
development.
    Even as we strive to reduce the prevalence of fossil fuel 
in our energy portfolio, pragmatism requires that we diversify 
to the greatest extent possible our sources of oil and natural 
gas. I have supported opening ANWR for exploration. While we 
continue to debate production there and on the outer 
continental shelf, we have to carefully consider both the 
security and economic benefits of more exploration, as well as 
the environmental costs.
    We must also ensure that we are not wasting fossil fuel 
resources in end-use that could be fueled by other means. I am 
encouraged by DuPont's commitment to replacing petrochemicals 
with bio alternatives. This wise business choice leaves DuPont 
less vulnerable to price spikes than competitors who still rely 
exclusively on oil and gas.
    With natural gas prices high, there is now a shift to coal-
fired electrical generation. New plants should favor coal, 
which we have in abundance, over natural gas. I continue to 
vigorously support the deployment of clean coal technology with 
carbon sequestration.
    We can also use coal to reduce our oil dependence. The 
energy bill included legislation I coauthored with Senator 
Obama authorizing $85 million for federal research into the 
production of coal-based transportation fuels. One of the 
technologies that will be encouraged by this program, the 
Fischer-Tropsch process, yields a diesel fuel that is 
compatible with existing vehicle technology. It is superior to 
oil-derived fuel with respect to performance and emissions.
    Another critical component of reliability is protection of 
the physical infrastructure and transit of our energy supplies. 
Terrorists have made clear their intentions to destroy 
refineries and pipelines worldwide. At home, in addition to 
power plants, ports, refineries, and platforms, we have 160,000 
miles of oil pipelines. As the United States considers 
liquefied natural gas and nuclear facilities, we must be 
vigilant to the security implications.
    While diversity in supplies at home and abroad is necessary 
for more reliable energy in the coming decades, diversification 
of sources for oil and gas is an outdated strategy that will 
never bring energy security. Reserves are too concentrated and 
infrastructure too vulnerable. Real diversity can only be 
achieved by an energy portfolio dominated by sustainable 
energy, the final component of energy security.
    As we make policies to influence the composition of our 
future energy portfolio, we should strive to consume fewer 
hydrocarbons than we can produce domestically. This means more 
clean coal and renewable fuels of all types. I am encouraged 
that some states and municipalities are taking the initiative 
to increase their use of renewables. With Congressman Pete 
Visclosky, I am advocating a bill that will do that for 
Indiana.
    Our policies should be targeted to replace hydrocarbons 
with carbohydrates. Obviously this is not a short-term 
proposition, but we can off-set a significant portion of demand 
for oil by giving American consumers a real choice of 
automotive fuel. We must end oil's near monopoly on the 
transportation sector, which accounts for 68 percent of 
American oil consumption.
    I believe that biofuels, combined with hybrid and other 
technologies, can begin to move us away from our extreme 
dependence on oil in the next decade. Corn-based ethanol is 
already providing many Midwesterners with a lower cost fuel 
option. Most of this is in a 10-percent ethanol mix, which is 
fully compatible with nearly all vehicles. I have recently 
called for my home State of Indiana to mandate that all gas 
stations in the state offer a 10-percent blend.
    Cellulosic ethanol, which is made of more abundant and less 
expensive biomass, is poised for commercial take-off. I am 
pleased the President now supports the ethanol research that 
began under my legislation in 2000. I have long championed a 
renewable fuels standard, and we finally passed a 7.5 billion 
gallon ethanol mandate in the 2005 energy bill. The bill I am 
cosponsoring with Senators Bayh and Lieberman will increase the 
proportion of ethanol from cellulose that will be in that mix.
    As our domestic ethanol industry strengthens and demand 
grows, we will have to revisit the tariff we put on ethanol 
imports. We do not want to trade oil import dependency for 
biofuel import dependency, but trade in alternative energy also 
creates jobs, provides new markets for our advance technology, 
and diversifies our own supply. In the end, I believe the 
United States is well positioned to produce ethanol at 
competitive rates.
    We have to make sure that consumers have access to E-85 
ethanol. Already there are millions of E-85 capable vehicles on 
the road. I have introduced legislation that would require 
manufacturers to install flexible-fuel technology in all new 
cars in the next 10 years. This is an easy and cheap 
modification, which allows vehicles to run on a mixture of 85 
percent ethanol and 15 percent gasoline, and will make their 
products more attractive to consumers.
    Next we have to make sure that consumers can buy the E-85 
fuel. I'm pleased that many independent gas station owners are 
taking advantage of the tax credit for E-85 pump installation 
that we passed in the energy bill. I have cosponsored 
legislation that would back loans for even more E-85 pumps. The 
next challenge is to get E-85 distributed through the big gas 
station chains. I've asked the oil majors about this, and they 
have said that sufficient demand for E-85 does not exist. But 
demand will not develop for something that consumers do not 
have an option to buy. It is time for the oil companies to make 
E-85 available to the consumer. If these companies do not take 
advantage of the incentives Congress has provided, I would be 
in favor of legislation mandating that they install E-85 pumps 
in appropriate markets.
    There is still more work to be done to tilt our energy 
balance toward alternative fuels. That is why Senator Obama and 
I will soon introduce a new bill that will promote other means 
to move these fuels into additional markets and make them more 
widely available for consumers. Among many provisions, the 
Obama-Lugar bill would create an alternative diesel standard 
comparable to the renewable fuels standard that I helped put 
into the 2005 energy bill. It would also provide new incentives 
for the production of flexible fuel vehicles. We believe that 
U.S. national security will be served by more robust 
coordination of all the elements that contribute to energy 
security. Consequently, the bill also would establish the post 
of Director of Energy Security, who would answer to the 
President.

                          energy partnerships

    As we pursue energy security at home, we must seek energy 
partnerships abroad. This week, I will introduce framework 
legislation that calls for a realignment of our diplomatic 
priorities to meet energy security challenges. Partnerships 
with foreign governments can help speed our conversion to real 
energy security, rebalance power in geopolitics, and open new 
markets for fuel technologies.
    The ``Energy Diplomacy and Security Act'' calls upon the 
Federal Government to expand international cooperation on 
energy issues. This bill will enhance international 
preparedness for major disruptions in oil supplies. A 
particular priority is to offer a formal coordination agreement 
with China and India as they develop strategic petroleum 
reserves. This will help draw them into the international 
system, providing supply reassurance, and thereby reducing 
potential for conflict.
    The bill would also stimulate regional partnerships in the 
Western Hemisphere. Most of our oil and virtually all of our 
gas imports come from this Hemisphere. The bill creates a 
Western Hemisphere Energy Forum modeled on the APEC energy 
working group. This would provide a badly needed mechanism for 
hemispheric energy cooperation and consultation.
    Finally, the bill calls for international partnerships with 
both energy producers and consumers. In addition to seeking new 
avenues of cooperation, the bill is intended to give focus to 
existing bilateral energy dialogues, which have lacked clear 
objectives and political backing.
    We must engage major oil and natural gas producers. We 
should advocate more transparency, improved investment 
climates, and greater infrastructure security. Oil exporting 
states wield power for which we must account. Not working with 
these states will lead to unproductive political showdowns and 
conflict. Even in challenging relationships such as Venezuela 
and Russia, we must explore how to improve our energy dialogue.
    Strategic energy partnerships with other major consuming 
countries are crucial for our national security. Energy 
security is a priority we hold in common with other import 
dependent countries, which constitute 85 percent of the world's 
population. Strategic partnership for energy security with the 
world's largest consumers will increase leverage in relation to 
petro-states. In November, I introduced S. 1950, a bill that 
specifically targets India for enhanced cooperation on 
alternative energy sources, such as clean coal technology and 
biofuels.
    To close, I would like to express my optimism for the 
future. Our current energy balance is the result of industrial 
and consumption choices of the past. Despite our import 
dependence today, the United States is in a strong position to 
choose a different path, a path toward real energy security. 
Success would free future generations of Americans from the 
energy dilemma that threatens to compromise our security and 
prosperity. It could also lead to opportunities in many new 
industries that could reinvigorate our economy. These are 
problems that can be solved. We must act now. We must act 
together.
    Thank you.
                  ``OIL DEPENDENCE AND ECONOMIC RISK''

                        Wednesday, June 7, 2006

                                ------                                

                           Opening Statement

                         HON. RICHARD G. LUGAR

                       U.S. Senator From Indiana,

            Chairman, Senate Committee on Foreign Relations

                              ----------                              

    The Foreign Relations Committee meets today to continue our 
examination of the geopolitical consequences of energy 
imbalances and U.S. dependence on energy imports. In previous 
hearings, we have focused on quantifying the costs of U.S. 
energy dependence and examining options for improving our 
energy security. We also have explored in detail how energy is 
shaping our relationships with other nations, including India, 
China, and the Persian Gulf states. Later this month, we will 
have hearings that look at energy in the context of our 
relationships with Latin America and Russia.
    Today, with the help of our esteemed witness, former 
Federal Reserve Chairman Alan Greenspan, we will have a unique 
opportunity to examine the economic effects of U.S. energy 
dependence. We are delighted that Chairman Greenspan has joined 
us today. He has given extraordinary service to our country 
over many years, and nobody speaks with greater authority on 
the U.S. economy. His presence here, for his first 
congressional testimony since leaving the Federal Reserve, is a 
testament to the economic importance he ascribes to solving our 
energy dilemma.
    The Foreign Relations Committee has devoted intense 
scrutiny to energy issues because we believe that America's 
national security and economic well being depend on reducing 
our dependence on foreign oil and establishing more 
predictable, transparent, and cooperative relationships with 
both producer and consumer nations. To this end, I have 
introduced the Energy Diplomacy and Security Act. This bill 
would strengthen U.S. diplomatic capabilities related to energy 
and encourage greater international cooperation on energy 
security.
    As Secretary Rice stated before this committee, our 
diplomatic activities around the world are being ``warped'' by 
petro-politics. Important foreign policy goals--from 
accelerating progress in the developing world and expanding 
trade, to preventing weapons proliferation and promoting 
democratic reform--are being undermined by international energy 
imbalances that have weakened our foreign policy leverage, 
while strengthening the hand of oil-rich authoritarian 
governments. In a speech in March at the Brookings Institution, 
I outlined these dynamics in greater detail, and I ask those 
remarks be entered into the record.
    As recently as 4 years ago, spare production capacity 
exceeded world oil consumption by about 10 percent. As world 
demand for oil has rapidly increased in the last few years, 
spare capacity has declined to less than 2 percent. Any major 
disruption of oil creates scarcity that will drive prices up. 
Our vulnerability was made clear to Americans after the 
devastation of Hurricanes Katrina and Rita. But even as 
supplies rebounded from those disasters, we experienced a 
continued upward trend in oil prices. Events such as the civil 
unrest in Nigeria, uncertainty over Iran's nuclear program, and 
worries over Venezuelan supply have kept the price of oil above 
$70 a barrel.
    Our capacity to deal with these energy vulnerabilities in a 
foreign policy context is shaped in part by the ability of our 
own economy to adjust to changing energy markets. Eventually, 
because of scarcity, terrorist threats, market shocks, and 
foreign manipulation, the high price of oil will lead to 
enormous investment in and political support for alternatives. 
The problem is that by the time sufficient motivation comes to 
markets, it may be too late to prevent the severe economic and 
security consequences of our oil dependence.
    Today, we will have the benefit of Chairman Greenspan's 
insights into the risks of oil dependency to our economic 
prosperity. We are interested in a clearer picture of how 
current high energy prices are affecting our economy, how our 
economy may react to certain types of supply disruptions, and 
what steps we should take as a nation to reduce the economic 
risks of our energy vulnerability.
    We welcome Chairman Greenspan to the Foreign Relations 
Committee and thank him for lending his expertise to our 
ongoing inquiry.

                           Opening Statement

                       HON. JOSEPH R. BIDEN, JR.

                      U.S. Senator From Delaware,

         Minority Leader, Senate Committee on Foreign Relations

                              ----------                              

    Dr. Greenspan, welcome.
    Mr. Chairman, today's headlines make clear just how 
important this hearing is. On one hand, we have concern about 
inflation--led by petroleum-based energy costs that increased 
at a 61-percent annual rate in the first quarter of this year.
    And on the other hand, we have our financial markets roiled 
by the worry that the Federal Reserve's prescription--
continuing a course of 15 straight rate increases--could put 
the brakes on an economy that may already be slowing down.
    We could not have clearer evidence of our country's 
vulnerability to global oil prices.
    I am pleased to be working with you, Mr. Chairman, on this 
series of hearings on the cost of our dependence on imported 
oil, and to join you in our search for alternatives.
    Today we are privileged to have former Federal Reserve 
Chairman Alan Greenspan, who guided our Nation's monetary 
policy for almost two decades, through a wide variety of 
domestic and international challenges, and through profound 
changes in our economy.
    No one in the world who spoke on economic affairs was more 
listened to than Alan Greenspan. Not always understood, but 
listened to. It is a little daunting to have before this 
committee not only someone of your stature, Dr. Greenspan, but 
someone who once warned an audience, ``If I turn out to be 
particularly clear, you've probably misunderstood what I 
said.''
    Your pronouncements can still move markets, but I hope your 
new life in the private sector will allow you more freedom of 
speech than you enjoyed in your last job.
    We will need candor and clarity, if we are to understand 
and confront the challenges before us.
    The last time you appeared before this committee, we were 
facing the Peso crisis, the first wave of international 
financial crises in the late 1990s. The topic of today's 
hearing presents threats of a similar magnitude to our economy, 
and to our security.
    Today we are concerned about fundamentals, about the fuels 
that make our economy run, and about threats to our economic 
security because we do not control access to those fuels. And 
we are looking for ways we can move to more secure sources in 
the near future.
    Our failure to set a national energy policy to reduce our 
consumption of oil has handcuffed our foreign policy and 
weakened us economically.
    Global oil consumption--especially with the extremely rapid 
modernization of countries like China and India--is growing 
faster than the discovery and development of new supplies.
    Supply has never been so tight relative to demand. We now 
live in a world that consumes 85 million barrels of oil every 
day. It's an enormous amount. Meanwhile, worldwide spare 
production capacity has shrunk to just 2 percent of demand. And 
that means the slightest thing--a terrorist attack in Saudi 
Arabia, tough talk from Iran, violence in Nigeria, or even a 
bad storm in our own gulf region--can cause oil markets to 
panic.
    Here in the Foreign Relations Committee, we deal every day 
with the foreign policy implications of our dependence on 
imported fossil fuels. Most obviously, there are our complex 
relationships with what Michael Mandelbaum and others have 
called the ``Axis of Oil,'' the oil-rich regimes around the 
world.
    This dependence has a pernicious effect on our foreign 
policy. It literally helps to fuel the terrorism we are 
fighting, because some of the dollars we spend on crude oil 
wind up in the pockets of radicals. It limits our options and 
limits our leverage in dealing with national security threats, 
because oil rich countries can stand up to us, and oil 
dependent countries are afraid to stand with us. And it 
undercuts our hopes for advancing democracy and freedom, 
because repressive regimes, swimming in a sea of high-priced 
oil, can resist pressure to reform.
    To cite just one example, Iran's most recent threats to 
disrupt oil exports--as a direct response to our attempts to 
deal with their nuclear ambitions--was immediately translated 
into an increase in oil prices--a jump to $73 a barrel. Not 
just economic forces, but political conflicts, drive this 
market.
    We are here today to hear from Dr. Greenspan about the 
economic impact of oil and gas prices. During his long tenure 
as Chairman of the Federal Reserve, oil and gas prices spiked 
dangerously several times.
    Dr. Greenspan has repeatedly warned us about the potential 
impact of those fundamental energy prices on inflation as they 
worked their way through the economy, as well as their 
potential to slow economic activity as consumers and producers 
moved limited dollars from other sectors to cover energy costs.
    In your last Monetary Report to Congress last year, Dr. 
Greenspan, you placed significant stress on the potential 
problems that could arise from the jump in energy prices. You 
reported then that the impact they could have on consumer 
spending--the hit to the average American's pocketbook--would 
depend on how much incomes were growing. On that front, the 
news is not encouraging.
    The latest reports from the job market show yet another 
disappointingly small increase in the number of Americans 
finding work, and the persistence of very troubling stagnation 
in wages. Something is wrong, this far into an economic 
recovery, when the job picture is this weak.
    Wages are still flat--up just a penny an hour. That's 40 
cents for a 40-hour work week. And the cost of living--
including the cost of gasoline, and everything made and 
transported with petroleum--continues to grow faster than 
incomes.
    The cost of gasoline went up over 2 cents a gallon last 
week. That's over 40 cents more for a 20-gallon tank of gas. 
That means that higher prices for gasoline really hurt real 
families. Gas is pretty much a fixed cost for the average 
American family who can't switch cars or move closer to work. 
For them, this is not an abstract discussion.
    Here is what the wall Street Journal wrote last Friday: 
``Rising Energy Costs Pinch Low-Income Shoppers.''
    Slow job growth, flat wages--American households are part 
of the context we need to understand the impact of oil prices. 
In the bigger picture, our dependence on foreign oil feeds a 
cycle of dependence on foreign lenders to finance it.
    Our trade deficit through March this year was $192 
billion--that's 6 percent of our economy. Thirty percent of 
that deficit--$65 billion--was the cost of our petroleum 
imports. That number could grow to $100 billion this year.
    To finance that trade deficit, we are borrowing from other 
countries. The supply of our debt will eventually outrun 
demand. As we are already seeing, that means a weaker dollar, 
making importing oil--and the thousands of other consumer goods 
from cars to computers--even more expensive. Until we do 
something about our dependence on imported oil we will not be 
in control of our economic security.
    We can restore our energy security by reducing our 
consumption of oil. We can make the most progress, in the 
shortest amount of time if we focus on the fuel we put in our 
cars and trucks. Seventy percent of the oil we consume is used 
in transportation. We can immediately begin reducing our oil 
consumption by switching to fuels we can grow at home and 
making better, more efficient use of the energy we consume.
    First we need to make sure we're all driving good cars by 
increasing fuel efficiency and requiring that every car sold in 
the United States is a flexible-fuel vehicle or FFV--that can 
run on alternative fuel like E-85--an 85-percent ethanol fuel 
blend.
    Second, we need to make sure that we're using good fuel by 
requiring that major oil companies add alternative fuel pumps 
to at least half of their gas stations. Finally, we need to put 
in place the market and infrastructure for alternative fuels so 
that as new, more advanced fuel technology--like cellulosic 
(switchgrass) ethanol--becomes widely available we have the 
cars and pumps for it ready to go.
    We have asked you here today to help us understand better 
the shape we are in today, and to draw on your experience to 
understand how we can manage the future.
    I look forward to your statement, Dr. Greenspan, and to a 
discussion of these and other issues before us.
    Thank you, Mr. Chairman.

                           Prepared Statement

                          HON. ALAN GREENSPAN

          President, Greenspan Associates LLC, Washington, DC

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                              JUNE 7, 2006

                              ----------                              

    Mr. Chairman, Senator Biden, and members of the committee, 
this morning I shall try to detail how the balance of world oil 
supply and demand has become so precarious that even small acts 
of sabotage or local insurrection have a significant impact on 
oil prices. American business, to date, has largely succeeded 
in finding productivity improvements that have contained energy 
costs. American households, however, are struggling with rising 
gasoline prices.
    Even before the devastating hurricanes of last summer, 
world oil markets had been subject to a degree of strain not 
experienced for a generation. Oil prices had been persistently 
edging higher since 2002 as increases in global oil consumption 
progressively absorbed the buffer of several million barrels a 
day in excess capacity that stood between production and 
demand. Today world oil production stands at about 85 million 
barrels a day, and little excess capacity remains. Just how 
much excess capacity, and of what quality oil, is a matter of 
debate. But no matter what the precise answer, the buffer 
between supply and demand is much too small to absorb shutdowns 
of even a small part of the world's production. Moreover, 
growing threats of violence to oilfields, pipelines, storage 
facilities, and refineries, especially in the Middle East, have 
increased the private demand to hold oil inventories worldwide. 
Oil users judge they need to be prepared for the possibility 
that at some point a raid will succeed, with a devastating 
impact on supply.
    For most of the history of oil, its producers and consumers 
determined its price. Only those who could physically store 
large quantities of oil had the ability to trade. But important 
advances in finance have opened the market to a much larger 
number of participants. There has been a major upsurge in over-
the-counter trading of oil futures and other commodity 
derivatives. Thus, when in the last couple of years it became 
apparent that the world's oil industry was not investing enough 
to expand crude-oil production capacity quickly enough to meet 
rising demand, increasing numbers of hedge funds and other 
institutional investors began bidding for oil. They accumulated 
it in substantial net long positions in crude oil futures, 
largely in the over-the-counter market. These net long futures 
contracts, in effect, constituted a bet that oil prices would 
rise. The sellers of those contracts to investors, when all of 
the offsetting claims are considered, are of necessity the 
present owners of the billions of barrels of private 
inventories of oil held throughout the world--namely, the 
producers and consumers.
    Even though inventories of oil have risen significantly in 
recent years, persistent upward price movements have made it 
apparent that the rise in investors' ownership claims to the 
world's oil inventories has likely exceeded the inventory 
increase. This implies a reduction in the unencumbered 
inventory holdings of producers and consumers. In other words, 
some part of the oil in the world's storage tanks and pipelines 
is spoken for by investors. The extent of the surge in 
participation by financial institutions in claims on real 
barrels of oil is reflected in the near tripling of the 
notional value of commodity derivatives (excluding precious 
metals) during the four quarters of 2005 reported by U.S. 
commercial banks. Most of those contracts are for oil. The 
accumulation of net long positions in oil on the New York 
Mercantile Exchange by noncommercial traders , which is to say 
by investors, has exhibited a similar pattern.
    The new participants, investors, and speculators, to the 
world's $2 trillion a year oil market are hastening the 
adjustment process that has become so urgent with the virtual 
elimination of the world supply buffer. With the demand from 
the investment community, oil prices have moved up sooner than 
they would have otherwise. In addition, there has been a large 
increase in oil inventories. In response to higher prices, 
producers have increased production dramatically and some 
consumption has been scaled back. Even though crude oil 
productive capacity is still inadequate, it too has risen 
significantly over the past 2 years in response to price.
    Hypothetically, if we still had the 10 million barrels a 
day of spare capacity that existed two decades ago, neither 
surges in demand nor temporary shutdowns of output from 
violence, hurricanes, or unscheduled maintenance would be 
having much, if any, impact on price. Returning to such a level 
of spare capacity appears wholly out of reach for the 
foreseeable future, however. This is not because there is any 
shortage of oil in the ground. The problem is that aside from 
Saudi-Aramco, few, if any, of national oil companies which own 
most of the world's proved oil reserves are investing enough of 
their surging cash flow to convert the reserves into crude oil 
productive capacity. Only Saudi-Aramco appears sufficiently 
concerned, at least publicly, that high oil prices will reduce 
the long-term demand for oil, which could significantly 
diminish the value of Saudi Arabia's--or indeed, any 
country's--oil reserves.
    Although outlays on productive capacity are rising, the 
significant proportion of oil revenues held as financial assets 
suggests that many governments perceive that the benefits of 
investing in additional capacity to meet rising world oil 
demand are limited. Moreover, much oil revenue has been 
diverted to meet the perceived high-priority needs of rapidly 
growing populations. Unless those policies, political 
institutions, and attitudes change, it is difficult to envision 
a rate of reinvestment by these economies adequate to meet 
rising world oil demand. Some members of the Organization of 
Petroleum Exporting Countries (OPEC) have recently announced 
expansion plans. But how firm such plans are, is difficult to 
judge. They and other nations have rebuffed offers by 
international oil companies to help tap their reserves. 
Opportunities to expand oil production elsewhere are limited to 
a few regions, notably the former Soviet Union.
    Besides feared shortfalls in crude oil capacity, the 
adequacy of world refining capacity has become worrisome as 
well. Over the past decade, crude oil production has risen 
faster than refining capacity. A continuation of this trend 
would soon make lack of refining capacity the binding 
constraint on growth in oil use. This may already be happening 
in certain grades of oil, given the growing mismatch between 
the heavier and more sour content of world crude oil production 
and the rising world demand for lighter, sweeter petroleum 
products.
    There is thus a special need to add adequate coking and 
desulphurization capacity to convert the average gravity and 
sulphur content of much of the world's crude oil to the lighter 
and sweeter needs of product markets, which are increasingly 
dominated by transportation fuels that must meet ever more 
stringent environmental requirements. Yet the expansion and 
modernization of world refineries are lagging. For example, no 
new refinery has been built in the United States since 1976. 
The consequence of lagging modernization is reflected in a 
significant widening of the price spread between the higher 
priced light sweet crudes such as Brent which are easier to 
refine and the heavier crudes such as Maya, which are not.
    To be sure, refining capacity does continue to expand, 
albeit too gradually, and oil exploration and development is 
continuing, even in industrial countries. Conversion of the 
vast Athabasca oil sands reserves in Alberta to productive 
capacity, while slow, has made this unconventional source of 
oil highly competitive at current market prices. However, 
despite improved technology and high prices, additions to 
proved reserves in the developed world have not kept pace with 
production; so those reserves are being depleted.
    The history of world petroleum is one of a rapidly growing 
industry in which producers have sought to provide consumers 
with stable prices to foster the growth of demand. In the first 
decade of the 20th century, pricing power was firmly in the 
hands of Americans. Even after the breakup of the Standard Oil 
monopoly in 1911, pricing power remained with the United 
States--first with the U.S. oil companies and later with the 
Texas Railroad Commission, which would raise limits on output 
to suppress price spikes and cut output to prevent sharp price 
declines.
    Indeed, as late as the 1950s, crude oil production in the 
United States (more than 40 percent of which was in Texas) 
still accounted for more than half of the world total. In 1951, 
excess Texas crude was poured into the market to contain the 
impact on oil prices of the nationalization of Iranian oil. 
Excess American oil was again released to the market to counter 
the price pressures induced by the Suez crisis of 1956 and the 
Arab-Israeli war of 1967.
    American oil's historical role ended in 1971, when rising 
world demand finally exceeded the excess crude oil capacity of 
the United States. At that point, the marginal pricing of oil 
abruptly shifted--at first to a few large Middle East producers 
and later to market forces broader than they, or anyone, can 
contain.
    To capitalize on their newly acquired pricing power in the 
early 1970s, many producing nations, especially in the Middle 
East, nationalized their oil companies. The full magnitude of 
the pricing power of the nationalized companies became evident 
in the aftermath of the oil embargo of 1973. During that 
period, posted crude oil prices at Ras Tanura, Saudi Arabia, 
rose to more than $11.00 per barrel, far above the $1.80 per 
barrel that had been unchanged from 1961 to 1970. The further 
surge in oil prices that accompanied the Iranian Revolution in 
1979 eventually drove up prices to $39 per barrel by February 
1981. That translates to $76 per barrel in today's prices.
    The higher prices of the 1970s abruptly ended the 
extraordinary growth of U.S. and world consumption of oil and 
the increased intensity of its use which were hallmarks of the 
decades following World War II. Since the more than tenfold 
increase in crude oil prices between 1972 and 1981, world oil 
consumption per real dollar equivalent of global gross domestic 
product (GDP) has declined by approximately one-third.
    In the United States, between 1945 and 1973, consumption of 
petroleum products rose at a startling average annual rate of 
4.5 percent, well in excess of growth of our real GDP. However, 
between 1973 and 2006, U.S. oil consumption grew, on average, 
at only .5 percent per year, far short of the rise in real GDP. 
In consequence, the ratio of U.S. oil consumption to GDP fell 
by half.
    Much of the decline in the ratio of oil use to real GDP in 
the United States has resulted from growth in the proportion of 
GDP composed of services, high-tech goods, and other less oil-
intensive industries. The remainder of the decline is due to 
improved energy conservation: greater home insulation, better 
gasoline mileage, more efficient machinery, and streamlined 
production processes. These ongoing trends seem to have 
intensified of late with the sharp, recent increases in oil 
prices.
    To date, it is difficult to find serious erosion in world 
economic activity as a consequence of sharply higher oil 
prices. Indeed, we have just experienced one of the strongest 
global economic expansions since the end of World War II. The 
United States, especially, has been able to absorb the huge 
implicit tax of rising oil prices so far. However, recent data 
indicate we may finally be experiencing some impact.
    Clearly, if the current almost nonexistent supply buffer 
were significantly increased through a step-up in supply or a 
stepdown in consumption, oil prices would fall, perhaps 
sharply. This would likely occur even if there were no decrease 
in the threat to oil facilities from attacks or hurricanes. A 
large enough buffer could absorb such contingencies with modest 
impact on price.
    But for good reason, holders of claims to the existing 
private inventories of oil apparently do not foresee a 
likelihood of change sufficient to alter the current outlook. 
This does not mean that oil prices will necessarily move 
higher, however. All of the concerns about future contingencies 
are already discounted in today's spot price. It will require a 
change in the outlook one way or the other to move crude oil 
prices. History tells us that will happen--often.
    The U.S. economy has been able to absorb the huge impact of 
rising oil prices with little consequence to date because it 
has become far more flexible over the past three decades owing 
to deregulation and globalization. Growing protectionism would 
undermine that flexibility and make our nation increasingly 
vulnerable to the vagaries of the oil market.
    Current oil prices over time should lower to some extent 
our worrisome dependence on petroleum. Still higher oil prices 
will inevitably move vehicle transportation to hybrids, and 
despite the inconvenience, plug-in hybrids. Corn ethanol, 
though valuable, can play only a limited role, because its 
ability to displace gasoline is modest at best. But cellulosic 
ethanol, should it fulfill its promise, would help to wean us 
of our petroleum dependence, as could clean coal and nuclear 
power. With those developments, oil in the years ahead will 
remain an important element of our energy future, but it need 
no longer be the dominant player.
                 ``ENERGY SECURITY AND OIL DEPENDENCE''

                         Tuesday, May 16, 2006

                                ------                                

                           Opening Statement

                         HON. RICHARD G. LUGAR

                       U.S. Senator From Indiana,

            Chairman, Senate Committee on Foreign Relations

                              ----------                              

    The Foreign Relations Committee meets today to consider 
strategies for reducing dependence on oil. This dependence 
brings intolerable costs to American national security and 
economic well being. If oil averages just $60 a barrel this 
year, the import cost to the U.S. economy will be approximately 
$320 billion. This revenue stream emboldens difficult oil-rich 
regimes and enables them to entrench corruption and 
authoritarianism, fund anti-Western demagogic appeals, and 
support terrorism. As global oil demand increases and the world 
becomes more reliant on reserves concentrated in unstable 
regions, the likelihood of conflict over energy supplies will 
dramatically increase, and energy rich countries will have more 
opportunity to use their energy exports as weapons against 
energy poor nations.
    High prices over the past 10 months have demonstrated the 
vulnerability of supply. A global oil market tightened by 
under-investment in production and surging global demand has 
been aggravated by hurricanes, unrest in Nigeria, speculation 
about developments in Iran, weakened capacity in Venezuela, and 
terrorist activity in Iraq and elsewhere. In this environment, 
the price shock from a major supply disruption could cause a 
recession.
    Today, we will concentrate on how our government can speed 
up the transition to alternative sustainable energy sources. We 
are cognizant that despite past campaigns for energy 
independence and a constant improvement in energy intensity per 
GDP, we are more dependent on oil imports today than we were 
when President Nixon authorized ``Project Independence'' in 
1973. Yet, I believe that we are turning a corner. The American 
public and elected officials are becoming more aware of the 
severe problems associated with energy dependence and are more 
willing to take aggressive action.
    The new realism of energy geopolitics requires us to 
abandon the notion that simply finding more oil will solve oil-
driven threats to our national security. More than three-
quarters of the world's oil reserves are controlled by foreign 
governments. With global oil demand projected to rise from 83 
million barrels a day to 120 million barrels per day by 2030, 
the security threats related to oil dependence will continue to 
intensify, unless we make dramatic changes in policy.
    Efforts to reduce oil consumption must focus on developing 
sustainable fuels and increasing efficiency. I am pleased that 
the first commercial scale cellulosic ethanol plant in the 
United States is ready for construction and that Americans are 
beginning to demand more fuel efficient vehicles. We must 
continue investing in advanced energy research, but threats to 
our national security require us to efficiently deploy the oil-
saving technology that is available now.
    The benefits of reducing oil use at home will multiply when 
other countries also switch to alternative fuels and decrease 
the energy intensity of their economies. I have introduced S. 
2435, the Energy Diplomacy and Security Act to reorient our 
diplomatic activities to give greater priority to energy 
matters. We need bold international partnerships to blunt the 
ability of producer states to use energy as a weapon, to 
increase our own security of supply, and to reduce the 
vulnerability of our economy to high oil prices.
    Today we will benefit from the views of two distinguished 
experts. We will ask them to identify the best options for 
reducing oil use through alternatives and efficiency gains. We 
will also seek their counsel on what government can do to 
accelerate the transition away from oil and how we can most 
effectively encourage helpful actions by the private sector and 
consumers.
    First, we will hear from Mr. Vinod Khosla, the founding 
partner of Khosla Ventures, a leading venture capital firm that 
has invested in many cutting edge energy technologies. A 
cofounder of Sun Microsystems, Mr. Khosla, is an influential 
voice on the viability of alternative energy sources. Next, we 
will hear from Mr. Jason Grumet, Executive Director of the 
National Commission on Energy Policy. In December 2004, the 
bipartisan commission released its recommendations for a long-
term energy strategy. The report comprehensively examined 
numerous technologies and methods for increasing energy 
supplies, as well as for moderating energy demand. Prior to 
joining the Commission, Mr. Grumet served as Executive Director 
of Northeast States for Coordinated Air Use Management.
    We welcome our witnesses and look forward to their 
insights.

                           Opening Statement

                       HON. JOSEPH R. BIDEN, JR.

                      U.S. Senator From Delaware,

         Minority Leader, Senate Committee on Foreign Relations

                              ----------                              

    With gasoline at $3 a gallon, and with our most pressing 
foreign policy challenges centered in the oil-producing 
countries of the world, today's hearing before the Foreign 
Relations Committee could not be more timely or more important.
    We heard a few weeks ago in this committee about the hidden 
costs of our dependence on foreign oil. The United States has 
just one-third of the world's oil reserves, and less than 5 
percent of its population, but we consume fully one-third of 
the global oil output.
    Over 60 percent of the world's oil reserves are held in the 
Middle East, and as one of our witnesses points out today only 
9 percent of world reserves are held in countries we would call 
``free.''
    We are dependent on oil, and that makes us dependent on 
countries with whom we will continue to have at best many 
differences and at worst open hostility. What Michael 
Mandelbaum has called ``the axis of oil''--an axis that 
stretches from Russia to Iran to Venezuela to Saudi Arabia--
will have as great an impact on our national security as the 
so-called ``axis of evil.''
    That dependence means we pay a huge price militarily for 
access to a resource that we cannot do without. One estimate 
suggests we pay as much as $825 billion a year in security 
expenditures to project our influence and secure access to oil.
    Some part of every dollar we pay for imported oil finds its 
way into the hands of our sworn enemies. As some observers have 
put it, the war on terror is the first war in which we are 
paying for both sides in the conflict.
    Disruption to our economy from interruptions in supply can 
be huge, and will grow as our dependence grows. As Alan 
Greenspan has warned us, all economic downturns since the 1970s 
have been preceded by spikes in the price of oil.
    We pay a price environmentally for our dependence on oil, 
most profoundly in dealing with the repercussions of climate 
change, driven by our use of fossil fuels.
    There can no longer be any doubt that our dependence on oil 
is a critical problem, one that must be addressed.
    The sheer size of this problem is such that there will be 
no quick fix. Oil represents about 40 percent of our energy 
consumption and we import about 60 percent of the oil we use. 
Fully 70 percent of our transportation is dependent on oil. 
That statistic will not be transformed overnight.
    But there are other statistics that will not change, as 
well. China has accounted for fully 40 percent of the recent 
increase in global oil demand. It will put another 120 million 
vehicles on the road over the next 5 years. Along with India, 
and a reindustrializing Eastern Europe, that growth in global 
demand is not going to be reversed.
    The fit between global supply and demand today is extremely 
tight. Billions of dollars of new investment may keep pace with 
demand, but will do little to ease the price at the pump. And 
new supply, from conventional or unconventional sources of oil, 
will only hasten the process of climate change, and will simply 
delay our transition to the alternatives than can address our 
addiction to oil.
    What are our alternatives to oil? In the short term, 
ethanol from corn could be a first step away from our oil 
addiction, by providing a liquid fuel that is compatible with 
existing internal combustion engines that power our cars, 
trucks, and buses. We will hear today about the costs and 
benefits of taking such a step, and the steps that must follow 
toward sugar or cellulosic ethanol.
    Ethanol will be just part of a broader energy policy that 
will reduce our dependence on oil, and will reduce the leverage 
that the oil producing nations have over our foreign policy and 
our national security.
    If it was not clear before, it is now. Domestic energy 
policy is at the center of our foreign policy.

                           Prepared Statement

                              VINOD KHOSLA

                Partner, Khosla Ventures, Menlo Park, CA

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                              MAY 16, 2006

                              ----------                              

    Good Morning. Chairman Lugar and esteemed members of the 
committee, I want to start by thanking you for allowing me the 
opportunity to speak to you today about our unique ability to 
secure America's energy independence. Since the President's 
State of the Union Address and rising prices at the pumps, 
there has been a lot of talk about our oil addiction. I come 
here to talk not about what must be done but rather how to get 
it done, simply and pragmatically, in a manner aligned with the 
major political interests that carry clout in this country. We 
can not only do the right thing, but also the politically 
correct thing, if each interest group compromises a little.
    If it were not for the rapid growth of our domestic ethanol 
industry, Americans would see gas prices approaching $4 a 
gallon with no real alternative or hope in sight. In 
comparison, the Department of Energy estimates ANWR drilling 
would save 1 cent per gallon at the pump by 2025. (As quoted in 
Fortune May 15, 2006) We could be the architect of a global 
development plan, a Marshall Plan for our times that would 
support technological advancements and sustainable development 
of a global alternative to petroleum . . . and best of all it 
takes very little money to do so.
    I come to you today with ambitious goals, but goals that 
are grounded in sound science, technology and business. I am 
convinced that we can replace the majority of our petroleum 
used for cars and light trucks with ethanol within 25 years. 
This is not an alternative fuel--it can be a mainstream fuel. 
More importantly, with a few simple policy changes, we can be 
irreversibly traveling down this path in less than 7 years.
    You may ask, ``why ethanol''? Ethanol is substantially 
cheaper to produce today than gasoline before all subsidies and 
taxes. For example, the cost to produce ethanol in Brazil is 
less than $0.75 per gallon, while a U.S.-based corn-to-ethanol 
plant's production costs are roughly $1.00 per gallon. That 
equates, even with U.S. costs, to about $1.25 per ``gasoline-
equivalent'' gallon of ethanol. Gasoline, on the other hand, 
costs $1.60-$2.20 or more per gallon to produce, depending upon 
the cost of a barrel of oil.
    Why shouldn't ethanol sell for much less than gasoline at 
the pump? Oil interests distort the price to ensure they don't 
lose their lucrative profit opportunity or temporary supply/
demand dynamics. As new technologies ramp up, ethanol can be 
cheaper than gasoline even if oil drops to $35-$40 per barrel--
a level it is not expected to reach, according to the EIA. In 
addition to lower cost, E-85 reduces volatile organic compounds 
by 15 percent, carbon monoxide by 40 percent, NOX by 10 percent 
and sulfate emissions by 80 percent when compared to gasoline, 
according to an estimate from one environmental organization.
    With ethanol, we get a fuel that is cheaper for consumers 
and automakers, cleaner and greener, and it takes Middle East 
terrorism-fueling dollars and moves them to rural America. We 
capitalize on American technology to create more jobs and 
cheaper transportation costs for the American public. What is 
wrong with this picture?
    What is the single biggest risk we face from the oil 
interests distorting the price to ensure they don't lose their 
lucrative profit opportunity? If you were making $36 billion of 
profit per year like Exxon, would you want things to change? 
Reports of oil company executives lying under oath are 
reminiscent of the 1985 price manipulation episodes, Enron's 
energy price manipulation, and other examples, be they Iran, 
Russia or Sudan. I personally received a warning from a senior 
executive of a major oil company that they could drop the price 
of oil if biofuels started to take off. We cannot let this 
opportunity slip away again.
    My friends from the Mid-West tell me ethanol is the talk of 
coffee shops there and may be the most important thing to hit 
rural America in 30 years. It may also be the most important 
thing for global peace and welfare, the climate crisis, and for 
consumers. Fortunately, at this time the environmentalists, the 
automakers the agricultural interests, the security and energy 
independence proponents, and even the evangelicals are all 
aligned. Finally, a cause all interests can rally behind. As 
Tom Freidman recites a New York Times poll: 89 percent of 
Americans favor a mandate of more efficient cars; 87 percent 
say no to a gasoline tax, but that figure drops to 37 percent 
if the tax is to ``reduce our dependence on foreign oil'' and 
to 34 percent if the tax is to ``reduce global warming.''
    The oil interests keep propagating myths like insufficient 
land, poor energy balance, and high production costs to curb 
enthusiasm for ethanol. This is reminiscent of the tobacco 
companies funding studies to prove that smoking does not cause 
cancer. The NRDC, more concerned about land use than the oil 
interest, estimate a modest 114m acres of land needs. Argonne 
National Labs and UC Berkley among many others have discounted 
the energy balance claims. In my opinion, these are bogus if 
not ill-intentioned claims and I will address these falsehoods 
one by one.

    Crop Land: Yields of corn are increasing in the United 
States and Brazil. Brazil has had a 4x increase since 1975 and 
knowledgeable scientists are forecasting another 4x in the next 
10 years. U.S. gallons per acre yields can reach 10x the 
current levels even without the innovations that are 
commonplace in Silicon Valley. Based on my forecasts, I can see 
my way to yields increasing more than 10x to between 3,000 to 
5,000 gallons per acre compared to 400 gallons per acre today, 
demolishing all land use and energy balance arguments. I agree 
with Rick Tolman, CEO of the National Corn Growers Association, 
who believes that corn can provide 14-17 billions of gallons of 
ethanol by 2015 without impacting food supply. Based on my 
forecasts, including the considerable upside afforded by 
technology innovations, biomass based ethanol can replace most 
of our gasoline needs in 20 years, using less than 60m acres of 
land.

    Energy Balance: The only study that claims corn ethanol has 
an unfavorable energy balance is an outdated study performed by 
Professor Pimentel. Both USDA & DOE affiliated researchers 
claim that Pimentel's 2005 study overstates energy 
requirements. Professor Kammen at UC Berkley further states 
that corn ethanol results in a more than 90 percent reduction 
in petroleum use and a moderate 10-30 percent reduction in 
greenhouse gases. The NRDC agrees, stating that: (1) Corn 
ethanol provides important fossil fuel savings and greenhouse 
gas reductions; (2) cellulosic ethanol simply delivers 
profoundly more renewable energy than corn ethanol; and (3) 
very little petroleum is used in the production of ethanol. 
From this information, the conclusion is that a shift from 
gasoline to ethanol will reduce our oil dependence.
    Though a 25-percent mileage reduction is the reality today, 
it can be immaterially small over time as engines are optimized 
for a flex-fuel world. Saab sells a model in Sweden that 
adjusts itself to take full advantage of E-85's higher octane--
100 to 105, versus 87 to 93 octane for gasoline. Called the 
Saab 9-5 BioPower, its turbocharged engine generates 175 
horsepower on gasoline and a whopping 215 hp on E-85. (USA 
Today, 5/4/2006). Even with the additional horsepower, the Saab 
9-5 only has an 18-percent lower mileage on ethanol. If the 
engine was designed to provide the 175 hp on ethanol, we would 
get an additional substantial step increase in ethanol mileage. 
This proves that engines can be optimized for ethanol, thus 
substantially eliminating the mileage penalty which has been a 
convenient excuse for the oil companies.
    In the United States in 2000 the ethanol industry sold 
about 1.6 billion gallons of ethanol at about $1.20 per gallon. 
By 2005, the industry more than doubled its sales to 4 billion 
gallons, at a price of about $1.50 per gallon. In my view 
plants can meet all their cash flow requirements and pay off 
construction debt at prices in the $1.30-$1.40 per gallon 
range, given a cost of production of roughly $1 per gallon 
without subsidies or tax credits. At today's prices of over 
$2.50 per gallon, ethanol producers can pay off their plants in 
just 11 months rather than the standard 7-year payoff period. 
It is indisputable that ethanol is not only cheaper to produce 
than gasoline at about $40/barrel, but also, that the returns 
can be outstanding. It is disturbing to me to see some factions 
calling for permanent extensions to the credits, instead of 
supporting a variable VEETC model, which is genuinely needed to 
prevent oil price manipulation by interested parties.
    We have sufficient land and the energy balances and 
economics are favorable for ethanol as a transportation fuel. 
All we need to do is kick start the process.
    Chairman Lugar and members of the committee, the time has 
come for us to ask ourselves: Do we want to feed our farmers or 
Middle-East terrorism? Do we want ANWR oil rigs or prairie 
grass fields? Fossil fuels or green fuels? Should we create 
farm jobs or Middle-East oil tycoons? Gasoline cars or cars 
that offer the choice of gasoline or biofuels? Expensive 
gasoline or cheaper ethanol? This appears to be nothing less 
than a Darwinian IQ test.
    Risk capital from investors is the only solution to the oil 
stranglehold. Three simple things that need a little bit of 
courage, but not a lot of money are sufficient to get this 
capital flowing. These three are:

          1. Mandate that at least 70 percent of the new cars 
        sold in America be FFVs by 2014 with 10 percent annual 
        increases starting with 20 percent by 2009, and that 
        all such cars, old and new, be provided with yellow gas 
        caps, with possible tax incentives of $50 per car.

          2. Mandate that 10 percent of all gas stations owned 
        or branded by major gas station owners offer at least 
        one ethanol pump. Alternatively, mandating a separate 
        RFS for E-85 and cellulosic ethanol, defined later, 
        would serve a similar purpose. For the first 20,000 
        stations that convert at least one pump, an incentive 
        can be offered up to $30,000 per station in the first 
        year, $25,000 per station in the second year and 
        $20,000 per year in the third year, the proceeds being 
        appropriated from the Leaking Underground Storage Tank 
        Fund or through a special tax on oil company profits, 
        up to a maximum of $600m over 3 years.

          3. Make VEETC credit variable with oil price varying 
        from $0.20 at current prices up to $0.80 instead of the 
        current $0.51 credit as oil prices vary from $70 to $30 
        per gallon. This will insure that OPEC or the National 
        oil companies cannot manipulate prices as easily, hence 
        driving ethanol producers out of business. Such credits 
        should expire once ethanol capacity exceeds 15 billion 
        gallons in this country.

    These three policies will assure investors that a permanent 
market will exist for ethanol and will not be subject to price 
manipulation by the oil nations. Billions of dollars will flow 
into the ethanol economy creating a permanent alternative to 
gasoline, without material government funds.
    In addition, certain other polices can accelerate the 
process but are not essential:

          1. Shift the $0.51 blender's credit to an ``ethanol 
        producers' credit,'' preferably to be used only for 
        plant construction instead of giving it to the oil 
        companies as a ``blender's credit.'' This will build 
        permanent U.S. capacity for new ethanol production, 
        independent of whether the ethanol is U.S.-made or 
        imported. In fact, this format will supply all the 
        capital required for plant construction the industry 
        needs to replace all our petroleum and can be 
        structured to be self-effacing when we reach 
        appropriate plant capacity.

          2. Allow imports of ethanol for consumption above the 
        RFS standard without tariff, subject to switching the 
        VEETC ethanol credit to one directed exclusively toward 
        building plant capacity in the United States. This will 
        create permanent capacity for ethanol production in the 
        United States. It is likely that we will see WTO action 
        challenging the tariff's legality. A proactive program 
        is more likely to be effective than a reaction in 
        hindsight to WTO action. Early availability of lower 
        priced ethanol in the market will accelerate the switch 
        to E-85 and take ethanol into the domain of a primary 
        replacement for gasoline instead of just being an 
        additive. Concurrent with this provision the ethanol 
        RFS can be extended to 12b gallons by 2015. Based on 
        the national security exemption of the WTO, an 
        incentive or VEETC like credit is probably allowable if 
        it is directed toward building ethanol fuel plant 
        capacity in the United States. An alternative would be 
        to eliminate the tariff only for E-85 ethanol use, 
        accelerating E-85 adoption while keeping the blending 
        market protected against imports. This would allow U.S. 
        farmers to ease the learning curve on ethanol costs. 
        Tariff removal could be coincident with funding of 
        additional E-85 stations.

          3. Institute a similar limited period credit for 
        cellulosic ethanol or monetize the current ``1.5 
        times'' credit for cellulosic ethanol defined in the 
        2005 energy bill.

          4. Institute separate RFS standards for E-85 (and 
        possibly cellulosic ethanol) to kick start the E-85 
        market, which is currently being discouraged by the oil 
        companies.

          5. Reform and strengthen CAFE, replacing CAFE mileage 
        with CAFE ``petroleum mileage'' to align and 
        incentivize automakers to promote the use of ethanol 
        and other gasoline alternatives, giving them credit for 
        any technology used to replace petroleum; in addition 
        to increases in mileage standards.

          6. Provide loan guarantees for the first few 
        cellulosic ethanol plants built with any new 
        technology.

          7. Institute a cap and trade system for carbon 
        trading. This could effectively reduce the price of 
        ethanol by as much as $0.20-$0.30 per gallon (based on 
        the current trading price of carbon in the European 
        Union) depending upon the ethanol production 
        technology. This would provide incentives to make corn 
        ethanol greener, and less dependent on fossil fuels.

          8. Switch agricultural subsidies from row crops to 
        energy crops.

    As oil prices continue to soar in the United States, I see 
the following. First, oil companies use big budget advertising, 
expensive PR firms and armies of accountants to prove they are 
not making too much money while making more money than any 
industry has ever made in the history of the corporate world. 
It is amazing what money can buy.
    Second, oil companies blame everybody but themselves, but 
more importantly are doing relatively little to invest in 
alternatives to gasoline, other than token investments and PR 
campaigns.
    Third, they put obstacles in the way of their franchisees 
who want to offer ethanol instead of offering E-85 themselves. 
Why don't we require them to sell ethanol at least 10 percent 
of their gas stations? We have CAFE standards for automakers, 
why not E-85 green fuel standards for the oil companies?
    Finally, with a fraction of their oil profits invested in 
new ethanol capacity or ethanol distribution we could be 
producing tens of billions of gallons of ethanol and solving 
our addiction to oil. Instead they are sending these profits to 
the Mideast instead of creating jobs in the USA. Are they 
entitled to their profits? I believe they are. But that should 
not prevent us from developing alternatives to their 
stranglehold on our transportation fuel for the good of 
society. Here are some examples of why it is clear we need to 
reign in big oil:

          1. Gov. Pataki proposed a new bill in New York. The 
        bill would exempt renewable fuels from the provisions 
        of ``exclusivity'' contracts between fuel providers and 
        retail service stations, which only allow the service 
        stations to sell specific brands of fuel. In most 
        cases, these brands do not include renewable fuels. 
        Since the ``exclusivity'' contracts prohibit service 
        stations from obtaining renewable fuels like ethanol 
        (E-85) from other sources, these fuels are not 
        available for sale to consumers. The Governor's 
        proposal would exclude renewable fuels from these 
        contracts if the distributor does not offer these types 
        of fuels.

          2. A Mobil gas station in St. Louis does not allow 
        the use of credit cards for payment and warns against 
        ethanol. This is typical of how oil companies 
        discourage consumer use with scary notices. An Exxon in 
        Brazil stated that for all flex fuel vehicles every 
        third fill-up should be with gasoline, another 
        falsehood.

          3. The Foundation for Consumer & Taxpayer Rights 
        released a new study of rising gasoline prices in 
        California that found corporate markups and 
        profiteering are responsible for spring price spikes, 
        not rising crude costs or the national switchover to 
        higher cost ethanol, as the oil industry claims. One 
        can find the study at: http://www.consumerwatchdog.org/
        energy/rp/6132.pdf

          4. The 1985 price manipulation and recoupling of an 
        economy that was decoupling from oil is well known.

    Gaining independence from foreign oil would not be unique 
to the United States. I just recently returned from Brazil, 
which has declared independence from foreign oil. Let me share 
some insights with you.
    I got a very instinctive good feeling about carbon capture. 
As I looked at sugarcane varieties capable of producing 200 
(wet) tons per hectare I could imagine the sound of carbon 
dioxide getting sucked out of the atmosphere. My estimates of 
less than 60 million acres required to fuel most of America's 
cars and light trucks by 2030 started to feel conservative as I 
saw Brazilian entrepreneurs developing technologies to produce 
over 3,000 gallons per acre. Imagine what would happen if we 
let Silicon Valley entrepreneurs and American scientists and 
technologists innovate in this area. Some fraction of the land 
used for export crops could replace much of our gasoline needs. 
We must signal to our innovators that this is a long-term, 
large market, as Brazil has done.
    As I saw bagasse roll off the conveyor belts into heaps of 
waste for burning, it struck me that because of the 
preprocessing already done on this waste material it could 
produce cellulosic ethanol very soon. Even today's 
semideveloped cellulosic ethanol processes could make economic 
sense without waiting for full development. Orange peels from 
Florida and wood chips from our Northwestern forests would be 
next in line.
    It became clear that America, Brazil, Australia, India, and 
Africa could each produce enough ethanol to meet their local 
gasoline replacement needs and then export enough to serve much 
of the planet.
    It was surprising to learn that the average wage at Cosan, 
the largest Brazilian ethanol producer, was many times the 
average for similar industries in Brazil. Over a million jobs 
had been created in the ethanol economy in Brazil. Ethanol 
produces substantially more jobs per dollar invested than oil 
does.
    Almost astounding was the claim by some entrepreneurs that 
they could see technology driving costs well below 50 cents per 
gallon. There is no reason U.S. ethanol production costs won't 
come down too. The big manufacturers confirmed their ability to 
produce ethanol at below 75 cents a gallon today. Why are we 
paying over $3 a gallon for our gasoline?
    If ethanol supplies run low Brazilian producers can switch 
production in hours away from sugar to produce more ethanol. 
Consumers constantly switch back and forth between ethanol and 
gasoline based on cost and availability. Wouldn't it be nice if 
consumers here had a choice and were not held hostage by oil 
companies?
    It was embarrassing to see Brazilian experts laugh at the 
myths U.S. energy companies spread, like we cannot use the same 
storage tanks or tanker trucks or transport ethanol in 
pipelines. They have been doing this for years with no adverse 
consequences. Why do we let people interested in slowing down 
biofuels spread these myths by turning molehills into 
mountains? Surely, some issues exist but they are easily 
resolved in the context of a market as large as the 
transportation fuels market. I was passionate about ethanol 
before I went. Going there seemed to completely confirm the 
potential and opened my eyes to all sorts of new possibilities.
    Finally, I will leave you with some thoughts on why now is 
the time to take action. We have a climate crisis, we have an 
energy crisis, and we have a terrorism crisis and they are all 
coupled. The price of oil is up, the cost of ethanol production 
is down and we have a visible climate crisis and an 
overwhelming terrorism crisis. Economics and the right thing 
coincide this time around. Consumer pull has been proven in 
Brazil. Our risks are minimal. According to the firm Expansion 
Capital Partners, clean, or green, technologies netted less 
than 1 percent of venture capital funds 6 years ago. Today, 
however, the figure has risen to 8 percent, the firm told 
TechNewsWorld. (http://www.technewsworld.com/story/50076.html) 
Recent news reports that the U.S. insurance industry has 
decided to formally study the relationship of global climate 
change to rising insurance costs and availability concerns.
    Geopolitics & OPEC politics deserve a special mention. 
Venezuelan President, Hugo Chavez, is poised to launch a bid to 
transform the global politics of oil by seeking a deal with 
consumer countries which would lock in a price of $50 a barrel, 
according to the Monday April 3, 2006 issue of ``The 
Guardian.'' A long-term agreement at that price could allow 
Venezuela to count its huge deposits of heavy crude as part of 
its official reserves, which Caracas says would give it more 
oil than Saudi Arabia. A $50-a-barrel lock-in would open the 
way for Venezuela, already the world's fifth-largest oil 
exporter, to demand a huge increase in its official oil 
reserves--allowing it to demand a big increase in its 
production allowance within OPEC. Venezuela holds 90 percent of 
the world's extra heavy crude oil--deposits which have to be 
turned into synthetic light crude before they can be refined 
and which only become economic to operate with the oil price at 
about $40 a barrel. Newsnight cites a report from the U.S. 
Energy Information Administrator Guy Caruso suggesting 
Venezuela could have more than a trillion barrels of reserves.
    Saudi Arabia's Oil Minister scorned the popular notion that 
America can achieve energy independence as a myth (SF 
Chronicle, May 3, 2006).
    Iran, China, India, Sudan, Nigeria, Venezuela, Argentina, 
and Bolivia are all responding to the scramble for oil. Rules 
and principles go by the wayside given the urgency of energy 
needs for each nation.
    Asset valuation--increase in Venezuela and Saudi Arabia 
(each) asset values of over a trillion for every $4 rise in the 
price of a barrel of oil. According to press reports, for 
similar reasons, the U.S. oil companies have resisted inventory 
revaluation methods proposed by FASB.
    I came to you today with ambitious goals. I hope that you, 
too, are convinced that we can replace the majority of our 
petroleum used for cars and light trucks with ethanol within 25 
years. More importantly, with a few simple policy changes, we 
can be irreversibly traveling down this path in less than 7 
years and achieve energy independence, reduce greenhouse gas 
emissions, and create more jobs for rural Americans. I thank 
you for your time and attention.

                           Prepared Statement

                            JASON S. GRUMET

 Executive Director, National Commission on Energy Policy, Washington, 
                                   DC

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                              MAY 16, 2006

                              ----------                              

                              INTRODUCTION

    Good day, Chairman Lugar and members of the committee. I 
have the privilege to speak to you today on behalf of the 
National Commission on Energy Policy (NCEP), a diverse and 
bipartisan group of energy experts that first came together in 
2002 with support from the Hewlett Foundation and several other 
leading philanthropies. In December 2004, the Commission 
released a report entitled ``Ending the Energy Stalemate: A 
Bipartisan Strategy to Meet America's Energy Challenges.'' The 
first chapter of that report was about oil security because our 
Commission believed then, and still does, that oil security is 
one of our nation's foremost economic, national security and 
energy challenges.
    This isn't news to anyone, of course--least of all this 
committee. In fact, as national policy obsessions go, America's 
oil dependence has been one of our most enduring. For more than 
50 years, Congress and multiple administrations of either party 
have decried our reliance on imported oil and vowed to do 
something about it. Today, with oil prices topping $70 per 
barrel and gasoline prices at $3 per gallon, we are again 
enmeshed in an active debate over energy policy. The lack of 
real options to address near-term energy prices is a source of 
great frustration here in Congress and throughout the country. 
The challenge we face is to move beyond slogans, blame, and 
false promise of ``quick fixes'' and seize upon this moment of 
collective focus to develop long-term policy responses that 
will meaningfully protect our economy while strengthening our 
national security.
    The basic elements of an effective response to our current 
oil predicament are as easy to summarize as they are difficult 
to execute. Put simply, the Commission believes we must:

          1. Expand and diversify supplies,

          2. Reduce demand, and

          3. Develop alternatives.

    At the outset, I want to stress four themes that I hope 
will resonate throughout my remarks. First, the elements 
identified above are complementary components of an effective 
strategy. If they are not pursued in concert the effort will 
fail. We must have supply increases and demand reductions. We 
must pursue greater vehicle fuel economy and aggressive efforts 
to displace petroleum with biofuels. Simply put, we must move 
beyond divisive and false choices to develop a comprehensive 
approach that does not seek to trade one element off against 
the success of another.
    Second, until, and unless, private markets reflect the full 
economic, security, and environmental costs of oil dependence--
and until, and unless, consumers possess adequate information 
to make efficient choices--policies that rely solely on private 
market decisions will continue to fail. It is therefore 
incumbent upon government to overcome market barriers and 
motivate private sector innovation by creating incentives that 
better reflect the true benefits of greater energy security.
    Third, improving our energy security is a long-term 
challenge. If we commit the nation to a fundamental course 
correction, a secure energy future is within our reach. It will 
take several years, however, before we begin to reap the 
benefits of improved policies and technologies. During this 
time, the problem of high prices and tight supplies will almost 
certainly get worse as growth in petroleum demand continues to 
outstrip the rate at which vehicle fuel economy improves and 
new sources of oil come on line. While biofuels hold great 
potential, near-term gains will also be incremental when 
compared against our annual petroleum consumption. If history 
is a guide, public interest and support for long-term policies 
will wax and wane as the price of gasoline rises and falls. A 
real solution therefore will require the kind of commitment, 
consistency, and courage our nation has mustered in the past 
when we understood that our future was at risk.
    Finally, we must better understand and articulate the risks 
of oil dependence and establish goals that encourage consistent 
progress and accountability. I believe that our failure over 
the past 30 years to implement measures commensurate with the 
risks is in part due to widely held misconceptions about the 
true nature and scope of the problem and to our inability to 
establish realistic interim goals and mechanisms to measure our 
progress in achieving them.
Rethinking ``Energy Independence''
    Before delving into solutions, I would like to take on the 
somewhat heretical task of challenging the aspiration of 
``energy independence'' with its attendant focus on reducing 
our nation's use of ``foreign oil.'' While emotionally 
compelling, these concepts are vestiges of a world that no 
longer exists. By failing to recognize the fundamentally global 
nature of the oil market, and the increasingly global nature of 
markets for natural gas, the call for energy independence has 
become an obstacle to effective policy design. There is one 
world market for oil. It is a fungible global commodity that 
has a single benchmark price. Wide disparities in the price of 
gasoline around the world are the product of national subsidies 
and taxes, but have nothing to do with how much oil different 
nations import or produce. Our economic vulnerability to oil 
price shocks is entirely a function of how much oil we use--the 
continent from which the oil was extracted has no bearing 
whatsoever on this equation.
    Moreover, as members of this committee know better than 
anyone else, some of the most profound consequences of 
America's dependence on oil go well beyond the economic. It's 
virtually impossible to put a dollar figure on all the costs of 
that dependence, but there is no question that our thirst for 
oil constrains our foreign policy, imposes burdens on our 
military, accounts for approximately for one-third of the U.S. 
current account deficit which soared to $805 billion in 2005, 
swells the coffers of undemocratic and even actively hostile 
governments, and directly or indirectly provides some of the 
funding for terrorist organizations that mean us harm. These 
risks and vulnerabilities too, like those we face strictly in 
terms of our own economic well-being, will surely continue to 
grow if we don't take action. Put simply, if current trends 
don't change we face a global scramble for energy resources 
within this century that is sure to be economically and 
geopolitically damaging to all concerned.
    Confronted with these realities it is tempting--but wrong--
to imagine that if we could only become energy self-sufficient 
everything would be fine. I can't underscore this point too 
strongly: energy ``independence'' must not be confused with 
energy ``security.'' Energy independence is simply unrealistic 
and has been ever since President Nixon first proposed to 
enshrine it as a national goal in the 1970s. U.S. oil imports 
have been rising inexorably ever since. The United States alone 
currently accounts for fully one-quarter of world oil demand. 
What may be less well known is that we are also the world's 
third largest oil producer at present. But this will not last 
forever. Our nation holds less than 3 percent of the world's 
proved oil reserves. Sixty-one percent of world reserves, by 
contrast, are located in the Middle East.

                       World's Proved Oil Reserve*
------------------------------------------------------------------------
                                                           Percent of
                        Region                           World's Proved
                                                            Reserves
------------------------------------------------------------------------
Middle East..........................................               61.7
Europe/Eurasia.......................................               11.7
Africa...............................................                9.4
South & Central America..............................                8.5
North America........................................                5.1
Asia Pacific.........................................                3.5
------------------------------------------------------------------------
* = Only 9% of world reserves are held by countries considered ``free''
  by Freedom House.

    Current projections indicate that oil production by the 
United States and other industrialized countries will decline 
by 6 percent over the next two decades, even as oil production 
in the former Soviet Union increases by nearly 50 percent and 
OPEC output increases 33 percent. This means that U.S. oil 
imports will continue to grow in the future, as they have for 
the last several decades, and that we like everyone else will 
increasingly need to rely on oil supplies that originate in 
what are now unstable and undemocratic regions of the world. 
Nor will our dependence on foreign sources of energy be limited 
to oil: given declining domestic production of natural gas--
another fuel that plays an extremely important role in the U.S. 
economy--it appears inevitable that we will increasingly need 
to rely on overseas sources for natural gas as well. The key, 
then, to greater energy security for the United States lies in 
recognizing--and better managing--our fundamental energy 
interdependence.
Oil Market Fundamentals
    Nearly all experts agree about the fundamental drivers 
behind today's high oil prices and extreme market volatility. 
For some time now, rising global demand for petroleum--driven 
not only by growing U.S. demand, but in part by the very rapid 
modernization of countries like China and India--has been 
outpacing the discovery and development of new sources of 
supply. The result is that we now live in a world that requires 
approximately 85 million barrels of oil daily, but has only 
very little spare production capacity (as little as 2 percent, 
according to various estimates) and barely sufficient refining 
capacity. In this environment even small disruptions along the 
supply chain can cause serious repercussions. The dynamics are 
further strained by OPEC's ability to manipulate production 
quotas and by the participation of market players that operate 
on motives outside the bounds of economic efficiency. 
Unfortunately, this set of conditions seems unlikely to change 
soon. U.S. and total world demand for oil are expected to 
increase substantially over the next 20 years. Between 2004 and 
2025, U.S. demand is projected to grow 24 percent (from 21 to 
26 million barrels per day) and total world demand is expected 
to increase 34 percent (from 82 to 110 million barrels per 
day). (In the last year, the U.S. Energy Information Agency has 
downgraded its 20-year domestic demand projection by 3 million 
barrels a day based on expectations that high global prices are 
here to stay.) The world is suffering from what can best be 
described as a ``demand shock`` as China, India, and much of 
the developing world, modernize their economies and 
dramatically increase their use of motor vehicles. Equally 
concerning, there is currently very little spare capacity in 
the global oil market to make up any shortfall in oil supplies 
that arises as a result of political instability, unforeseen 
demand growth, acts of terrorism, or weather-related events. In 
2005, global spare production capacity totaled approximately 
1.5-2.0 million barrels per day; by contrast spare production 
capacity in 2001 was approximately 7.3 million barrels per day. 
This means that any event that prevents even a relatively small 
amount of oil from reaching today's global markets can have a 
dramatic impact on prices.
    In partnership with the organization, Securing America's 
Energy Future (SAFE), NCEP has been exploring the potential 
consequences of today's tight supply margins by examining the 
impacts of any number of possible disruptions in global oil 
supply. With help from industry and military experts, as well 
as from the Wall Street analysis firm Sanford C. Bernstein and 
Co. LLC, we concluded that any number of truly unexceptional 
circumstances could cause global oil prices to literally sky 
rocket. As part of an oil crisis simulation called Oil 
ShockWave, we found that a mere 4-percent shortfall in daily 
world oil supplies could lead to a 177-percent increase in 
world prices. It wouldn't take much, in other words, to send 
oil prices even higher--perhaps significantly higher--than they 
already are. With the U.S. transportation system over 97 
percent reliant upon petroleum, the impacts of such an increase 
could be devastating. As then Chairman of the Federal Reserve 
Alan Greenspan observed in 2002, ``All economic downturns in 
the United States since 1973 have been preceded by sharp 
increases in the price of oil.''
A Better Goal for Oil Security
    If we accept that the key measure of our energy security is 
not how much oil we import, but how much our economy depends on 
oil, we can begin to articulate more realistic goals and 
actually set about achieving them. In fact, the oil intensity 
of the U.S. economy, as measured by gallons consumed per dollar 
of GDP generated, was cut in half between 1975 and 2000. There 
were multiple reasons for this decline and they are worth 
reviewing as we explore our policy options for the future. 
First, there were structural shifts in the U.S. economy that 
led to reduced oil consumption, including a shift to less 
energy-intensive enterprises generally, together with more 
efficient oil use in some industries and a shift away from oil 
to different fuels altogether in other industries, notably in 
the electric power sector. Second, and very important, were 
vehicle fuel economy standards introduced in the late 1970s 
that doubled the average mileage of our passenger car and 
light-duty fleet.
    An ambitious goal is to cut the oil intensity of the U.S. 
economy in half again over 20 years. To achieve this goal would 
require roughly a 7.25 million barrel per day reduction in oil 
consumption by 2025. Unfortunately, progress in further 
reducing the overall oil intensity of the American economy has 
slowed in recent years, while progress in improving the 
efficiency of the nation's vehicle fleet has stalled 
altogether. But for a modest recent increase in light-truck 
standards, fuel economy requirements for passenger vehicles 
have been essentially unchanged since 1980. As a result, 
average fleet efficiency actually began to decline in recent 
years as large trucks and SUVs captured ever larger shares of 
the U.S. auto market. Simply stated, the United States will not 
have a serious policy to increase oil security until we achieve 
a significant increase in the fuel economy of our vehicles.
    A fundamental premise underlying the Commission's oil 
security recommendations is the belief that we can neither 
drill nor conserve our way to energy security. We simply must 
address both the supply and demand sides of the equation if we 
are to have any hope of lasting success. As Congress and 
ordinary Americans search for solutions to the current costs of 
gasoline, it is painfully clear that there are no good near-
term options. We must accept this unfortunate reality and 
direct our attention to minimizing the harmful effects of the 
oil shocks that are likely to occur with increasing regularity 
and severity over the next 20 years.
Solutions
    As noted at the outset, the Commission believes that there 
are three essential elements to enhanced oil security: 
Increasing supply, reducing demand, and developing 
alternatives. The first two of these imperatives can be seen as 
buying us time to achieve the more fundamental benefits of a 
diversified portfolio of transportation fuels. We must seek to 
widen the gap between available supply and demand in the short- 
to medium-term as a means of calming today's extremely volatile 
markets and putting downward pressure on prices, even as we 
begin developing clean and affordable alternatives for the 
long-term. The Commission's specific recommendations for 
widening the gap on the supply side include:

          1. Expanding and diversifying conventional supplies 
        of oil, both at home and abroad;

          2. Expanding the global network of strategic 
        petroleum reserves; and

          3. Exploring technologies and processes that would 
        allow for the use of unconventional oil resources in a 
        manner that is compatible with climate change and other 
        environmental concerns.

    On the demand side, the Commission recommends:

          1. Significantly strengthening fuel economy standards 
        for new passenger vehicles, while simultaneously 
        reforming the existing CAFE program to reduce 
        compliance costs and provide cost-certainty for 
        manufacturers and consumers;

          2. Creating incentives to accelerate the market 
        penetration of highly efficient hybrid vehicles while 
        also helping the domestic auto industry retool to meet 
        growing demand for these vehicles; and

          3. Exploiting opportunities to boost the efficiency 
        of heavy-duty vehicles and to improve the fuel-economy 
        performance of the existing light-duty vehicle fleet.

    Finally, to develop long-term alternatives to petroleum, 
the Commission recommends a sustained and vigorous effort to 
spur public and private sector investment in the development 
and early deployment of domestically produced transportation 
fuels derived from biomass and organic wastes. Of all available 
alternatives to petroleum fuels, the Commission believes that 
cellulosic ethanol holds the most potential for displacing a 
significant fraction of transportation oil demand within the 
next 20-30 years and should therefore be a focus of near-term 
RD&D activities.
    A summary of the potential benefits of supply and demand 
measures can be found at Appendix A.
Oil Supply Measures
    The Commission believes that opportunities exist to 
substantially boost global oil production within the next 10 to 
20 years. This would help to relieve upward price pressures and 
reduce the risk of significant supply disruptions over the same 
timeframe.

    Domestic Production: The United States is currently the 
third largest oil-producing nation after Saudi Arabia and 
Russia. As such, U.S. production clearly has a significant 
impact on the stability of the global oil market and efforts to 
expand production within our own borders must be pursued. 
Currently, the United States produces about 8.5 million barrels 
per day of oil (crude and products) and consumes about 21 
million barrels per day of finished oil products. Domestic oil 
production is important to the nation's economy--it remains an 
important source of jobs and tax revenues in some regions of 
the country--and it offers the important advantage of reducing 
financial transfers to foreign nations. Although domestic 
production has generally declined over the past decade, it is 
now projected to increase modestly in the near term (1 million 
barrels per day in 2016) and to resume a gradual decline 
thereafter.
    The United States is thought to have about 25 billion 
barrels of proved, conventional oil reserves, the great 
majority in Alaska and off our Pacific Coast with a smaller 
fraction off the Atlantic Coast and the eastern Gulf of Mexico.

                  U.S. Proved Conventional Oil Reserves
------------------------------------------------------------------------
                                                           Crude Oil
                Conventional Reserves                     (billions of
                                                            barrels)
------------------------------------------------------------------------
Alaska (ANWR)........................................              10.36
Pacific Offshore.....................................              10.71
Eastern Gulf of Mexico...............................               3.58
Atlantic Offshore....................................               2.31
------------------------------------------------------------------------

    Though technically recoverable, much of this oil is 
currently off-limits to leasing. If all of it were tapped, it 
is estimated that U.S. oil output could be increased by about 2 
million barrels per day in 2020. Obviously, many issues must be 
considered in weighing whether it is appropriate to open a 
particular area to oil drilling and the Commission takes no 
position on whether the status of specific regions that are 
currently off-limits should be changed. To provide a sound 
basis for future decision-making, however, the Commission does 
believe that an inventory of domestic petroleum reserves should 
be undertaken as part of a regular, comprehensive assessment of 
the nation's known and potential energy resources. Again, 
however, it cannot be stressed often enough that while U.S. 
production makes an important contribution to global supplies 
(and hence is critical to maintaining the near-term stability 
of global markets), our nation's economic vulnerability to oil 
price shocks is largely a function of how much oil we use and 
not how much we produce.

    Global Production: Much more substantial oil reserves 
exist, of course, in other parts of the world, including--
besides the Middle East--parts of the former Soviet Union, 
Africa, and South and Central America. The Commission therefore 
recommends that the U.S. Government encourage nations with 
significant underdeveloped oil reserves to allow foreign 
investment in their energy sectors to increase global oil 
production. Kazakhstan, for example, provides an example of the 
benefits of liberalized investment policies. Having opened its 
oil resources to significant foreign investment in the mid-
1990s, Kazakhstan's crude oil production rate more than doubled 
between 1996 and 2002. Output from this one nation is now 
expected to reach 2 million barrels per day in the next few 
years and could peak at as much as 4 million barrels per day 
further down the road. The Commission also recommends that the 
U.S. Government consider impacts on world oil markets in cases 
where unilateral economic sanctions imposed by our nation may 
be limiting investment in foreign energy markets without 
necessarily achieving their stated policy objectives.

    Unconventional Oil Supplies: Accounting for unconventional 
oil supplies--such as tar sands in Canada, heavy oil in 
Venezuela, and oil shale in the United States--would 
significantly shift the hemispheric balance of world petroleum 
resources. With today's high prices, these unconventional 
resources are already being tapped to a greater extent and by 
2015 it is likely that Canada and Venezuela together will 
produce nearly 3.5 million barrels per day of unconventional 
crude. At the same time, the Fischer-Tropf process, which has 
been used for over 50 years to convert coal into a form of 
clean diesel fuel, could--at prices above $50 per barrel-- 
become a significant source of domestic transportation fuel.
    Further reliance on unconventional oil resources in the 
future, however, will require substantial progress toward 
reducing the substantial energy requirements and negative 
environmental impacts currently associated with extracting and 
processing them. Absent efforts to sequester the carbon used in 
producing unconventional oil, for example, the total greenhouse 
gas emissions associated with these resources are roughly two 
and a half times greater than the emissions associated with 
conventional oil production. While the Commission does not 
believe that our nation's oil policy must be viewed as a 
vehicle for achieving its climate protection objectives, it 
seems equally clear to us that it would be foolhardy to pursue 
an oil policy that is at odds with other compelling public 
policy objectives. Unless and until we learn how to develop 
these resources without significantly increasing greenhouse gas 
emissions, the Commission believes that exploiting 
unconventional oil reserves does not offer a viable long-term 
pathway toward a more secure energy future. Therefore, the 
Commission has recommended increased funding to improve the 
environmental performance of technologies and practices used to 
produce unconventional oil resources.

    Strategic Reserves: Oil stockpiles provide an important 
insurance policy against the potentially dire consequences of a 
significant short-term global supply disruption. Combined with 
private stocks, the U.S. Strategic Petroleum Reserve currently 
provides us with enough spare capacity to cover the loss of all 
imports for approximately 150 days, or a partial disruption for 
much longer. To improve global and domestic oil security, the 
Commission recommends that the U.S. Government work with other 
major oil-consuming nations to increase their public reserves 
and participate in the global network of strategic reserves.
    In particular, membership in the International Energy 
Agency (IEA) could provide major emerging oil-consuming nations 
like China and India with: (1) A greater feeling of ownership 
on their part in how the ``global energy system'' is run; (2) 
improved transparency in energy statistics and policymaking; 
and (3) an established forum to communicate concerns, success 
stories, and partnership ideas. IEA membership also brings with 
it a requirement that nations maintain strategic oil stocks 
sufficient to supply 90 days of demand and agree to manage them 
in coordination with IEA member countries (although this 
requirement is not legally binding). Because the IEA is a 
cooperative group of the Organization for Economic Cooperation 
and Development (OECD)--the IEA's 26 member nations include 
most OECD countries--a number of issues would have to be 
addressed with respect to the inclusion of currently non-OECD 
developing nations. In the past, initiation into the OECD has 
been a lengthy and sometimes controversial process in which 
standards of economic development, openness, and human rights 
are considered. Given the potential benefits noted above, 
however, possibilities for bringing countries like China or 
India into the IEA on an expedited or alternative basis--
perhaps with special observer or some other unique status--
should be explored.
Oil Demand Measures
    While the Commission firmly believes that both supply and 
demand measures must be pursued as part of an effective 
strategy to enhance the nation's energy security, it is 
important to emphasize that when it comes to protecting the 
economy from oil price shocks, a barrel produced and a barrel 
conserved are not the same thing. The benefits of every added 
barrel of supply--whether produced domestically or abroad--
accrue to oil consumers the world over, in the form of a 
marginal reduction in the market price. By contrast, the 
benefits that can be achieved through demand-side measures and 
alternative fuel production--besides being much larger in 
absolute magnitude--are largely captured by those who implement 
them. The Commission therefore devoted significant attention to 
the potential for reducing our nation's oil demand, 
particularly in the transportation sector, which--because it 
accounts for nearly 70 percent of current domestic consumption 
and is nearly solely dependent on petroleum fuels--is key to 
oil use in the broader U.S. economy.

    Strengthening and Reforming CAFE While Promoting Advanced-
Technology Vehicles and Addressing Jobs and Competitiveness 
Concerns: Improving passenger vehicle fuel economy is by far 
the most significant and reliable oil demand reduction measure 
available to U.S. policymakers. As noted previously, CAFE 
standards played an important role in substantially reducing 
the oil intensity of the U.S. economy between the late 1970s 
and early 1990s. However, a longstanding political stalemate 
has blocked significant progress in fuel economy for over two 
decades. People often confuse our failure to increase domestic 
fuel economy with the view that technology options for 
improving vehicle efficiency have not advanced over the past 
two decades. Nothing could be farther from the truth. The 
efficiency of our automobiles increases annually. Estimates of 
this annual increase vary substantially from a low estimate of 
roughly 1.5 percent per year to a high estimate of over 5 
percent per year. However, absent any requirement to direct 
these substantial efficiency gains toward achieving the public 
good of reduced oil dependence, vehicle manufacturers have 
instead devoted recent technological advancements to simply 
maintaining fuel economy while dramatically increasing vehicle 
size and power. While vehicle fuel economy is now no higher 
than it was in 1981, vehicle weight has increased by 24 percent 
and horsepower has increased by over 100 percent over this same 
time period. In fact, most of today's economy cars outperform 
the ``muscle'' cars of the 1970s. If we enhance the rate of 
efficiency advancement and channel the majority of this 
improvement into greater fuel economy, we can maintain the 
amenities of the current vehicle fleet while gradually 
increasing fuel economy every year.
    In proposing to significantly strengthen and reform vehicle 
fuel economy requirements, the Commission sought to address the 
three issues we believe are most responsible for the last two 
decades of stagnation in this critical policy area: (1) 
Uncertainty over the cost of future fuel-saving technology; (2) 
concern that more stringent standards will compromise vehicle 
safety; and (3) fears that new standards will put the U.S. auto 
industry and U.S. auto workers at further competitive risk 
relative to foreign automakers.

    CAFE Reform: Pairing a significant increase in standards 
with reforms that would make the CAFE program more flexible and 
reduce the compliance burden for manufacturers would help to 
address cost concerns. The Commission commends recent efforts 
by the National Highway Traffic Safety Administration (NHTSA) 
to introduce program reforms as part of its 2005 rulemaking to 
update CAFE standards for light trucks. Further reforms that 
should be considered include allowing manufacturers to trade 
fuel economy credits with each other and across the light truck 
and passenger vehicle fleets, as well as ``safety valve'' 
mechanisms that would set a defined upper limit on compliance 
costs in the event that fuel-savings do not mature as expected 
or prove more expensive than anticipated.
    The adequacy of NHTSA's authority to craft effective CAFE 
standards for passenger cars has recently been called into 
question. The Commission believes that NHTSA should be granted 
the requested authority and similarly that Congress should 
provide NHTSA with clear direction about how to apply it. When 
NHTSA sets new standards, the Agency seeks to fully offset the 
costs of new fuel-saving technology with the value of saved 
gasoline. This approach has obvious merit, but its application 
depends significantly upon NHTSA's ability to assess the full 
societal benefits of avoiding a gallon of gasoline consumption. 
At present, NHTSA lacks both the tools and authority to 
adequately factor in many of these broader externalities. This 
inability results in a systematic undervaluation of the 
benefits achievable through improved vehicle fuel economy and 
results in standards that are lower than would be justified by 
a more comprehensive assessment. It's not that NHTSA doesn't 
work hard to assess these externalities--in its recent light 
truck rulemaking, the Agency sought to include factors such as 
reduced vulnerability to oil price shocks, reduced air 
pollution, and even the value of spending less time at gas 
stations.
    However, NHTSA has no ability to quantify the value of 
reduced future tensions with China over tight oil supplies or 
the constraints that oil dependence imposes on our foreign 
policy. After considering the costs of protecting our access to 
global oil resources, NHTSA, in its recent rulemaking, decided 
not to include any value in reduced military costs as a result 
of increased fuel economy. The Regulatory Impacts Assessment 
reads:

          The U.S. military presence in world regions that 
        represent vital sources of oil imports also serves a 
        range of security and foreign policy objectives that is 
        considerably broader than simply protecting oil 
        supplies. As a consequence, no savings in government 
        outlays for maintaining the Strategic Petroleum Reserve 
        or a U.S. military presence are included among the 
        benefits of the light truck CAFE standard adopted for 
        MY 2008-2011.

    All told, NHTSA's recent rulemaking assesses total 
petroleum market externalities to be slightly less than 6 cents 
per gallon. When added to projected gasoline costs of $1.60 per 
gallon over the next decade ($2 pump price minus roughly $.40 
in taxes), NHTSA arrives at a total societal value of a gallon 
of gasoline saved at just under $1.70 gallon. This number 
clearly helps explain why the increase in truck standards that 
emerged from the rulemaking process was so modest.
    When considering the administration's recent request that 
Congress grant NHTSA broad authority to reform passenger car 
standards along the same lines as the recent light-truck 
rulemaking, Congress must also consider giving the agency 
specific, updated guidance about the factors to be considered 
in establishing standards and about how these factors should be 
weighted and analyzed. Moreover, given the apparent political 
difficulty of revisiting fuel economy regulations, Congress 
should also consider establishing--or directing NHTSA to 
establish--a dynamic fuel economy target that becomes gradually 
but steadily more aggressive over time, rather than picking a 
single number. A defined percent-per-year improvement goal, 
coupled with an effective cost-capping mechanism or well-
defined ``off-ramps'' in the event that later requirements 
begin to impose unacceptable tradeoffs in terms of cost or 
other vehicle attributes, may prove more effective over time 
and more palatable in the short run, than choosing a particular 
mpg requirement that remains fixed for years or even decades.

    Vehicle Safety: Safety concerns have long contributed to 
the prevailing CAFE stalemate, but there is reason for optimism 
that the terms of this debate, too, have begun to shift in 
important ways. First, the rapid emergence of hybrid-electric 
vehicle technology clearly demonstrates that substantial fuel 
economy improvements can be achieved while maintaining or even 
increasing horsepower and without reductions in vehicle weight 
or size. Second, a more sophisticated approach to the issue of 
safety--one that accounts for the impact of heavier vehicles on 
other vehicles in the event of a collision and their effects on 
overall fleet safety as well as on the safety of their 
individual occupants--has served to illuminate the fact that 
while the relationship between vehicle weight and safety is 
clearly important, it is far from straightforward. Finally, 
some argue that advances in light but very strong composite 
materials that allow for significant weight reductions to be 
achieved in concert with ongoing safety improvements--together 
with other advances in vehicle design and safety features--will 
prove fundamentally game-changing, although for now cost issues 
remain.

    Domestic Industry Competitiveness: Given the recent, well-
publicized troubles of U.S. automakers, concerns about jobs and 
competitiveness will continue to figure prominently in any 
debate over vehicle fuel economy. The Commission worked with 
the United Auto Workers and experts at the University of 
Michigan to assess the competitive impacts of a significant 
increase in fuel-economy requirements on the domestic 
automobile industry. Our analysis suggests that the domestic 
automakers currently are at a disadvantage, relative to their 
foreign competitors, in terms of the expertise and 
manufacturing capacity needed to design, produce, and 
incorporate the most advanced hybrid-electric and diesel 
technologies. Therefore the Commission urges policymakers to 
consider mechanisms for addressing jobs and competitiveness 
concerns that would strengthen the domestic industry and better 
position it to meet future global demand for advanced 
technology vehicles. Specifically, the Commission recommended 
in its 2004 report that consumer tax incentives to stimulate 
consumer demand for highly efficient, advanced-technology 
vehicles be extended and coupled with business tax incentives 
aimed at helping parts suppliers and manufacturers with U.S. 
facilities retool their plants to produce these vehicles. 
Importantly, the Commission's analysis showed that such 
incentives could be designed to ensure that their cost to the 
U.S. Treasury would be more than covered by the additional tax 
revenues associated with increased domestic production. In 
light of the fact that domestic manufacturers are presently 
losing money and hence not paying much in the way of taxes, 
additional work is underway to design alternative mechanisms to 
provide the suggested incentives.

    Oil Savings through Increased Fuel Economy: The oil savings 
achievable through improved new vehicle fuel economy depend, of 
course, on specific assumptions about how quickly and 
aggressively new standards would be introduced and on whether 
other aspects of the current CAFE program are reformed at the 
same time. Appendix A summarizes the results of a bounding 
exercise intended to portray the savings that could be achieved 
if new vehicles technologies were employed to increase fuel 
economy over the next 20 years. The results are cumulative 
(that is, each row includes the demand reductions associated 
with all of the rows above it) and reflect oil savings in 2025 
from a baseline business-as-usual demand forecast of 26 million 
barrels per day. The table suggests that the United States 
could reduce oil consumption in 2025 by 2.2 million barrels per 
day by implementing a 40-percent improvement in gasoline 
vehicle efficiency. If a significant fraction of fuel-efficient 
hybrid vehicles were added to the mix, the savings would rise 
to roughly 3.5 million barrels per day. Under the most 
aggressive scenario considered, U.S. oil consumption could be 
reduced by nearly 5 million barrels per day if the new-vehicle 
fleet in 2025 were comprised of a combination of efficient 
gasoline, gasoline hybrid and plug in hybrid vehicles.

    Fuel Economy Improvements in the Heavy-Duty Truck Fleet and 
Existing Light Vehicle Fleet: Smaller but nonetheless important 
opportunities exist to reduce U.S. oil consumption by improving 
the fuel economy of the heavy-duty truck fleet and of the 
existing light-car fleet. The Department of Energy's 21st 
Century Truck Program, for example, is being undertaken with 
the cooperation of major heavy-truck engine manufactures; it 
estimates that the fuel economy performance of so-called 
``Class 8'' long-haul trucks, which are the largest fuel 
consumers of all heavy trucks, could be improved as much as 60 
percent. Enhanced diesel technology and improved aerodynamics 
in the heavy-duty truck fleet could produce oil savings of as 
much as 1 million barrels per day in 2025. As an initial step, 
the Commission recommends that EPA be instructed to develop a 
test procedure to assess heavy-duty vehicle fuel economy so 
that we have an opportunity to seek reductions from this sector 
should the will to do so emerge in the future. For the existing 
light-duty vehicle fleet, simply ensuring that replacement 
tires have the same low rolling resistance as original-
equipment tires can improve vehicle fuel economy by as much as 
4.5 percent at very low cost to the vehicle owner.
    Efficiency improvements are important not only because they 
produce demand reductions that will allow us to ``buy time'' to 
develop new alternatives to oil (a serious effort to diversify 
our fuel supply will likely take decades), but because they are 
essential to making many of those alternatives technologically 
and economically viable on a commercial scale. Biofuels and 
most other alternative fuels suffer from feedstock constraints, 
a lower energy density than gasoline, or both. Unless the 
vehicle fleet becomes more fuel-efficient, efforts to promote a 
greater reliance on alternative fuels will likely falter due to 
inadequate supply or inadequate driving range. Conversely, the 
land requirements for cellulosic ethanol production or the 
battery requirements for a plug-in hybrid-electric vehicle 
become much more manageable if the vehicles that employ these 
fuels or technologies are also highly efficient to begin with. 
Once one recognizes that the successful development of 
petroleum alternatives depends on highly efficient vehicle 
technologies, it becomes apparent that current provisions 
intended to promote the production of flexible-fueled vehicles 
by providing credits that weaken overall fleet fuel economy are 
shortsighted and ultimately counterproductive.
Developing Alternatives to Oil
    The United States burns nearly 140 billion gallons of 
gasoline each year and relies on petroleum-based fuels to 
supply nearly all of its transportation energy needs. To 
meaningfully improve our nation's energy security, alternative 
transportation fuels must be capable of being economically and 
reliably produced on a truly massive scale. The Commission 
identified four criteria that characterize a promising 
alternative fuel: (1) It can be produced from ample domestic 
feedstocks; (2) it has low net, full fuel-cycle carbon 
emissions; (3) it can work in existing vehicles and with 
existing infrastructure; and (4) it has the potential to become 
cost-competitive with petroleum fuels given sufficient time and 
resources dedicated to technology development. Among the 
variety of alternative fuel options potentially available for 
the light-duty vehicle fleet, the Commission believes that 
ethanol produced from cellulosic biomass (i.e., fibrous or 
woody plant materials) should be the focus of near-term federal 
research, development, and commercial deployment efforts. Let 
me briefly discuss the attributes of traditional corn-based 
ethanol and then turn to cellulosic ethanol.
    Corn-based ethanol is far and away our most successful 
nonpetroleum transportation fuel. The Renewable Fuels Standard 
adopted in the 2005 Energy Policy Act imposes an annual ethanol 
sales requirement that grows to 7.5 billion gallons in 2012. 
Ethanol sales were roughly 4 billion gallons last year. Despite 
the beneficial sales-volume credits given to producers of 
cellulosic ethanol, virtually all of this mandate will be met 
with traditional corn ethanol. A requirement to sell 250 
million gallons of cellulosic ethanol takes effect in 2013. To 
an extent, Congress's effort to stimulate demand for cellulosic 
ethanol may be undermined by the unexpected demand for ethanol 
of any kind. Present expectations are that demand for ethanol 
will exceed the requirements of the RFS for most if not all of 
the program. In this context, credits may have little or no 
value and the 2.5:1 cellulosic credit advantage may provide no 
meaningful benefit. Congress may want to investigate other 
policy approaches to achieve the intended aims of these credit 
provisions.
    For years, detractors of corn-based ethanol have asserted 
that the energy content of a gallon of ethanol is matched or 
even exceeded by the energy required to produce it. The 
Commission's analysis disputes this conclusion, finding that 
corn-based ethanol provides nearly 20 percent more energy than 
it takes to produce. A more recent study by Argonne National 
Laboratory finds nearly a 35-percent benefit. Nevertheless, the 
fundamental liability of corn-based ethanol is that there is 
simply not enough corn to begin to keep pace with expected 
growth in transportation energy demand, let alone to reduce 
current U.S. gasoline consumption in absolute terms. Put 
simply, it takes roughly 4 percent of our nation's corn supply 
to displace 1 percent of our gasoline supply. Even 
organizations devoted to ethanol advocacy agree that it will be 
difficult to produce more than 10-12 billion gallons of ethanol 
a year without imposing unacceptable demands on corn supply and 
significant upward pressure on livestock feed prices.
    Cellulosic ethanol is chemically identical to corn-based 
ethanol and is equally compatible with existing vehicle 
technology and fueling infrastructure. The added advantages of 
cellulosic ethanol lie in its significantly lower energy inputs 
and greenhouse gas emissions, its much larger base of potential 
feedstocks, and its greater potential to become cost-
competitive with gasoline at very large production volumes. For 
cellulosic ethanol to succeed on a commercial scale, however, 
important concerns about land requirements must be overcome and 
production costs must be reduced. The central challenge is 
producing enough feedstocks without disrupting current 
production of food and forest products. Some cellulosic ethanol 
can be produced from currently available waste products such as 
corn stalks, sugar cane bagasse, and wheat straw. Production 
volumes on the order of 50 billion gallons per year, however, 
will require improved high-yield energy crops like switchgrass, 
the integration of cellulosic ethanol production into existing 
farming activities, and efficiency improvements in the 
processes used to convert cellulosic materials into ethanol.
    A Commission-sponsored analysis of the land required to 
produce enough cellulosic ethanol to fuel half of the current 
U.S. passenger vehicle fleet reveals the importance of the 
advancements noted above. Using status quo assumptions for crop 
yields, conversion efficiency, and vehicle fuel economy, Oak 
Ridge National Laboratory has estimated that it would take 180 
million acres or roughly 40 percent of the land already in 
cultivation in the United States to fuel half the current 
vehicle fleet with cellulosic ethanol. Estimated land 
requirements can be reduced dramatically--to approximately 30 
million acres--if one assumes steady but unremarkable progress 
over the next two to three decades to (1) double per-acre 
yields of switchgrass, (2) increase the conversion efficiency 
of ethanol production by one-third, and (3) double the fuel 
economy of our vehicle fleet. As a point of reference, there 
are roughly 30 million acres in the Conservation Reserve 
Program (CRP).
    Another central challenge is reducing production costs for 
cellulosic ethanol. Because energy crops like switchgrass can 
be grown with minimal inputs of energy, fertilizer, and 
pesticides, the use of such feedstocks offers obvious economic 
benefits, as does producing ethanol from materials that would 
otherwise be treated as waste. The National Renewable Energy 
Laboratory and a separate analysis sponsored by the Commission 
both suggest that mature cellulosic ethanol production could 
compete economically with gasoline. However, these studies are 
projections. At this time, no full-scale production of 
cellulosic ethanol exists anywhere in the world. Until 
cellulosic ethanol is produced in a variety of commercial 
facilities, it will not be possible to prove or disprove 
current cost estimates. These are serious challenges, but they 
are achievable if we dedicate ourselves to a serious, 
coordinated, and sustained research, development, and 
commercialization effort.
    As a critical first step in this direction, the Energy 
Policy Act of 2005 contains at least 10 major programs to 
promote ethanol derived from cellulosic feedstocks. These 
programs include explicit authorizations for more than $4.2 
billion over the next decade to support critical R&D as well as 
``first-mover'' commercial facilities through a combination of 
grants, loan guarantees, and production incentives. While these 
programs demonstrate Congress's clear intention to promote 
biofuels, continued vigilance will be required to ensure that 
this vision is achieved. Historically, efforts to promote 
biofuels have been undermined by a lack of appropriations, 
inconsistent funding year to year, and an unusual degree of 
congressional earmarks. These factors, if continued, will make 
it difficult to achieve the critical objective of diversifying 
our nation's fuel supply.
    The 2005 Energy Policy Act also took steps to ensure that 
increased use of ethanol will not undermine air quality and 
public health standards. Eliminating the opportunity for 
ethanol-blended gasoline to meet less protective evaporative 
emission standards remains necessary to ensure that our efforts 
to increase energy security do not undermine our clean air 
goals. Finally, carmakers will need to take some steps to 
better accommodate ethanol-blended gasoline. The Coordinated 
Research Council, which is supported by the automotive and 
petroleum industries and the State of California, has been 
conducting research to examine the extent to which automobile 
evaporative emissions increase in cars using ethanol-blended 
fuels. The research appears to indicate that when a small 
quantity of ethanol is blended into gasoline, the resulting 
mixture escapes more readily through the hoses and seals in the 
vehicle's fuel system leading to more smog-forming emissions. 
The problem appears less prevalent in newer vehicles but 
demonstrates the type of challenges that will arise as we begin 
to transition toward a more diverse suite of transportation 
fuels. One of the many reasons for interest in promoting 
flexible-fueled vehicles capable of running on up to 85 percent 
ethanol blends is that when ethanol is the dominant 
constituent, the overall volatility of the fuel is reduced and 
evaporative problems go away. Efforts by Chairman Lugar, 
Senator Obama, and others to increase the number of flexible-
fueled vehicles sold over the next decade and significantly 
increase ethanol refueling infrastructure deserve serious 
consideration.
    In sum, the Commission urges Congress to make every effort 
to fund the research and demonstration projects authorized in 
the Energy Policy Act of 2005. While it is clear that all 
discretionary programs must come under continual budget 
scrutiny, inconsistent funding from year to year can be 
devastating to long-term research efforts by making it 
impossible to hire and train experts, build infrastructure, and 
amass knowledge based on iterative experimentation. The 
Commission recognizes that Congress alone is responsible for 
appropriations, but can't help but note that the high level of 
noncompetitive earmarks is undermining the strategic goals of 
our nation's bioenergy programs. For example, in 2004, of the 
$94 million in appropriations for DOE's bioenergy programs, 
nearly $41 million was directed to earmarked projects. In 2005, 
earmarks accounted for nearly 50 percent of the program's 
budget. Paradoxically, this high level of earmarks reflects the 
enthusiasm of many Members of Congress for promoting domestic 
alternatives to petroleum. However, an effective national 
effort that coordinates the efforts of Federal, State, and 
private institutions cannot be mounted under these 
circumstances.
Conclusion
    Sadly, there are no good options for delivering immediate 
relief from high prices at the gas pump. And while it's 
understandable at times like this that people want to focus on 
price gouging, windfall-profits, or restrictive environmental 
laws--as if our plight was somehow the result of a few greedy 
people or poorly written statutes--we must direct the vast 
majority of our attention to confronting the fundamental roots 
of our oil security predicament. To make real progress, we must 
substitute thoughtful analysis for rhetoric and rise above the 
temptation to take political advantage of the current crisis by 
crafting a truly bipartisan response.
    Prices may, of course, fall again in the months ahead. But 
there is almost no scenario in which the underlying causes of 
the current crisis simply resolve themselves without a 
concerted effort by the United States and other major oil-
consuming nations to change course. The real tragedy would be 
if this ``moment'' simply passes as others have with no real 
progress toward a lasting solution. In short, there is no 
question that we will someday use less oil than we do now. The 
question is rather whether we arrive at that point on our own 
terms or on someone else's. The Commission believes that the 
sacrifices we choose are infinitely preferable to those imposed 
on us by forces we cannot control. The National Commission on 
Energy Policy looks forward to working with this committee in 
its ongoing effort to chart a more secure energy future for our 
nation.
                                ------                                

                               Appendix A

                                Summary of Measures for Improving U.S. Oil Supply
----------------------------------------------------------------------------------------------------------------
                                                                                 Projected Impact/Projected Oil
                                                         Measure                            Savings
----------------------------------------------------------------------------------------------------------------
Increasing Supply
                                            Exploit all domestic conventional  Increase U.S. output by 2.0 MBD
                                             reserves
                                            Exploit global reserves            Increase global supply by 4.0+
                                             ofunconventional oil               MBD
----------------------------------------------------------------------------------------------------------------
Reducing Demand
  Heavy Duty Trucks
                                            Enhanced Diesel Technology and     1.0 MBD
                                             Aerodynamics
                                            Reduce Average Highway Speed by    0.3 MBD
                                             10 mph
                                           ---------------------------------------------------------------------
  Passenger Vehicles and Delivery Trucks
                                            Advanced Gasoline Engine           2.2 MBD
                                             Technology (32 mpg)
                                           ---------------------------------------------------------------------
                                            Advance Gasoline Engine            3.5 MBD
                                             Technology + 50% Advanced Hybrid/
                                             Diesel Sales (40 mpg)
                                           ---------------------------------------------------------------------
                                            Advanced Gasoline Engine           4.6 MBD
                                             Technology + Advanced Hybrid/
                                             Diesel + 25% Plug-in Hybrids (50
                                             mpg)
----------------------------------------------------------------------------------------------------------------
DevelopingAlternative Fuels
                                            Quadruple ethanol production post- 2.0 MBD (30 billion gallons)
                                             2012
                                           ---------------------------------------------------------------------
                                            Dramatically increase biodiesel    0.5 to 1.0 MBD (7.5 to 15 billion
                                             production                         gallons)
                                            Create Domestic Fischer-Tropsch    0.5 to 3.0+ MBD (7.5 to 45+
                                             Industry (Coal to Diesel)          billion gallons)
----------------------------------------------------------------------------------------------------------------

                       ``THE HIDDEN COST OF OIL''

                        Thursday, March 30, 2006

                                ------                                

                           Opening Statement

                         HON. RICHARD G. LUGAR

                       U.S. Senator From Indiana,

            Chairman, Senate Committee on Foreign Relations

                              ----------                              

    The Foreign Relations Committee meets today to consider the 
externality costs of U.S. dependence on fossil fuels. The 
gasoline price spikes following the Katrina and Rita hurricanes 
underscored for Americans the tenuousness of short-term energy 
supplies. Since these events, there is a broader understanding 
that gasoline and home heating prices are volatile and can 
rapidly spike to economically damaging levels due to natural 
disasters, terrorist attacks, or other world events. But, as 
yet, there is not a full appreciation of the hidden costs of 
oil dependence to our economy, our national security, our 
environment, and our broader international goals.
    Today, with the help of experts who have thought a great 
deal about these issues, we will attempt to more clearly define 
some of these costs. We are cognizant that this is a difficult 
and imprecise exercise. We are also aware that most, if not 
all, energy alternatives have some externality costs. But we 
are starting from the presumption that if we blithely ignore 
our dependence on foreign oil, we are inviting an economic and 
national security disaster.
    With less than 5 percent of the world's population, the 
United States consumes 25 percent of its oil. If oil prices 
remain around $60 a barrel through 2006, we will spend 
approximately $320 billion on oil imports this year. Most of 
the world's oil is concentrated in places that are either 
hostile to American interests or vulnerable to political 
upheaval and terrorism. More than three-quarters of the world's 
oil reserves are controlled by national oil companies. And 
within 25 years, the world will need 50 percent more energy 
than it does now.
    These basic facts demand a major reorientation in U.S. 
policy aimed at reducing U.S. dependence on fossil fuels. Our 
goals must be to mitigate the short-term costs of our 
dependence on oil, while pursuing energy alternatives that 
would reduce the international leverage of petro-superpowers, 
improve environmental quality, cushion potential oil price 
shocks, stimulate new high-tech energy industries, and ground 
the American economy on energy sources that will neither run 
out nor be cut off by a foreign supplier.
    There are at least six basic threats associated with our 
dependence on fossil fuels. First, oil supplies are vulnerable 
to natural disasters, wars, and terrorist attacks that can 
produce price shocks and threats to national economies. This 
threat results in price instability and forces us to spend 
billions of dollars defending critical fossil fuel 
infrastructure and choke points.
    Second, over time, finite fossil fuel reserves will be 
stressed by the rising demand caused by explosive economic 
growth in China, India, and many other nations. This is 
creating unprecedented competition for oil and natural gas 
supplies that drives up prices and widens our trade deficit. 
Maintaining fossil fuel supplies will require trillions in new 
investment--much of it in unpredictable countries that are not 
governed by democracy and market forces.
    Third, energy rich nations are using oil and natural gas 
supplies as a weapon against energy poor nations. This 
threatens the international economy and increases the risk of 
regional instability and military conflict.
    Fourth, even when energy is not used overtly as a weapon, 
energy imbalances are allowing oil-rich regimes to avoid 
democratic reforms and insulate themselves from international 
pressure and the aspirations of their own people. In many oil 
rich nations, oil wealth has done little for the people, while 
ensuring less reform, less democracy, fewer free market 
activities, and more enrichment of elites. It also means that 
the United States and other nations are transferring billions 
of dollars each year to some of the least accountable regimes 
in the world. Some of these governments are using this money to 
invest abroad in terrorism, instability, or demagogic appeals 
to anti-Western populism.
    Fifth, reliance on fossil fuels contributes to 
environmental problems, including climate change. In the long 
run, this could bring drought, famine, disease, and mass 
migration, all of which could lead to conflict and instability.
    Sixth, our efforts to facilitate international development 
are often undercut by the high costs of energy. Developing 
countries are more dependent on imported oil, their industries 
are more energy intensive, and they use energy less 
efficiently. Without a diversification of energy supplies that 
emphasizes environmentally friendly options that are abundant 
in most developing countries, the national incomes of energy 
poor nations will remain depressed, with negative consequences 
for stability, development, disease eradication, and terrorism.
    Each of these threats comes with short- and long-term 
costs. As a result, the price of oil dependence for the United 
States is far greater than the price consumers pay at the pump. 
Some costs, particularly those affecting the environment and 
public health, are attributable to oil no matter its source. 
Others, such as the costs of military resources dedicated to 
preserving oil supplies, stem from our dependence on oil 
imports. But each dollar we spend on securing oil fields, 
borrowing money to pay for oil imports, or cleaning up an oil 
spill is an opportunity missed to invest in a sustainable 
energy future.
    Certain types of costs are extremely difficult to quantify. 
We understand that many national security risks are heightened 
by our oil dependence. But how, for example, would we assign a 
dollar figure to Iran's use of its energy exports to weaken 
international resolve to stop its nuclear weapons program?
    Yet we should do our best to quantify the externality costs 
of oil, so we have a clearer sense of the economic and foreign 
policy tradeoffs that our oil dependence imposes on us. As the 
U.S. Government and American businesses consider investments in 
energy alternatives, we must be able to compare the costs of 
these investments with the entire cost of oil. Public 
acknowledgement of the billions of dollars we spend to support 
what the President has called our ``oil addiction,'' would shed 
new light on investment choices related to cellulosic ethanol, 
hybrid cars, alternative diesel, and other forms of energy.
    As we address these questions today, we will have the 
benefit of a distinguished panel of experts. Dr. Hillard 
Huntington is executive director of the Energy Modeling Forum 
at Stanford University. He is a senior fellow and past 
president of the United States Association for Energy 
Economics. He recently coordinated two studies funded by the 
Department of Energy that evaluated the economic risks of oil 
price shocks. Mr. Milton Copulos is President of the National 
Defense Council Foundation. He has advised Secretaries of 
Defense, Energy, and Interior and was a member of the National 
Petroleum Council. He is widely published on military affairs 
and has devoted much study to the military expenditures 
associated with ensuring the flow of oil. Dr. Gary Yohe is the 
John E. Andrus Professor of Economics at Wesleyan University. 
Professor Yohe is widely published on the adaptation and 
mitigation of climate change. He recently edited Avoiding 
Dangerous Climate Change, the collection of papers on the 
subject that were prepared for last year's G-8 Summit.
    We welcome our three witnesses and look forward to their 
insights.

                           Opening Statement

                       HON. JOSEPH R. BIDEN, Jr.

                      U.S. Senator From Delaware,

         Ranking Member, Senate Committee on Foreign Relations

                              ----------                              

    Mr. Chairman, thank you for holding this hearing on the 
``Hidden Costs of Oil.''
    For most of us, the costs of oil seem far from hidden. They 
are right up there on the signs at our gas stations, they are 
there in black and white on our heating bills.
    But as our witnesses will show us today, the price at the 
pump, the price on our heating bills, as bad as they may be, 
are only part of the story.
    Those prices conceal the hidden tax we pay to OPEC 
countries who use their pricing power to charge us more than 
they could get in an open international market for oil.
    In addition, those prices conceal the costs of the security 
commitments we face to protect the supply of oil from OPEC and 
other foreign sources.
    And they conceal the costs to our foreign policy, which has 
been handcuffed for over half a century by our dependence on 
oil from parts of the world with very different interests from 
our own.
    At the same time, the rising price of oil has created a 
cushion that props up despotic regimes and finances their 
militaries or allows other countries to put off hard decisions 
about democratic and economic reform.
    Finally, the price at the pump hides the long-term 
environmental damage--as well as the economic and social 
disruptions--that will come with global warming.
    The economic, social, political, and environmental costs we 
face today--and the costs of dealing with their repercussions 
in the future--will not stay hidden.
    There is no free lunch, as economists never tire of telling 
us. Somebody eventually has to pick up the tab.
    When we pay too much for oil--because OPEC can use its 
market power--we have less money for other priorities. That 
artificial inflation affects both domestic and imported oil, 
since there is essentially just one world market for oil.
    In turn, we pay too much for transportation, and power. We 
pay too much for the plastics and other products derived from 
oil.
    That is a dead-weight loss for the entire economy. Every 
watt of electricity from our power plants, every minute we run 
a refrigerator or air conditioner, every trip to the store, 
everything shipped by truck or rail--all those parts of our 
everyday lives costs more than they should.
    That leaves us with less to spend on other priorities. It 
make us poorer--as individuals, as families, as a nation.
    Mr. Chairman, we often speak about the costs of our foreign 
policy--usually we are speaking metaphorically. We may talk 
about trading values or prestige in one area to secure 
influence or leverage in another.But there are real costs to 
our policies, too, of course. As hard as they may be to 
calculate, we must try to measure the economic costs of our 
reliance on oil, especially on imported oil, on oil from 
countries that are themselves unstable or that promote 
instability.
    That will be important testimony for the record of this 
committee, Mr. Chairman.
    Throwing our net a little wider, Mr. Chairman, from the 
quantifiable costs of oil to our economy, and the costs of our 
foreign entanglements to secure that oil, we come to the costs 
we will incur to cope with the climate change that will result 
from our use of oil and other fossil fuels.
    You and I share a concern about all of the foreign policy 
implications of climate change, Mr. Chairman. Climate change 
will alter growing seasons, redistribute natural resources, 
lift sea levels, and shift other fundamental building blocks of 
economic, social, and political arrangements around the world. 
It could spark massive human migrations and new wars over 
resources. We will pay a price for those, too.
    No other issue carries such a threat to our way of life. 
Putting a dollar value on that threat can show us what we are 
risking if we don't act now to slow global warming.
    In every one of the areas we will look at today, the near-
term prospects are grim. The rise of the massive economies of 
China and India will continue to put pressure on supply, will 
demand tens of billions in investments, will further complicate 
global oil and energy politics, and will accelerate the 
accumulation of carbon dioxide and other greenhouse gases.
    Half the world's population--3 billion people--live on $2 a 
day. Just to provide them with a little electricity to replace 
wood and kerosene for cooking, to pump water, to light a 
schoolhouse--will require more than our current energy system 
can provide.
    To meet the inevitable challenges built into our current 
fossil fuel economy, we must first start with the facts. Today 
we will learn the many ways the true costs of oil are hidden 
from us.
    To make clear choices, we need to have the right 
information. Hidden costs lead consumers to make the wrong 
choices. They distort investment decisions--we invest too much 
in systems that will make our problems worse, and we invest too 
little in solutions.
    This hearing will give us some of the facts we need to 
start making the right choices.
    Thank you, Mr. Chairman.

                           Prepared Statement

                           MILTON R. COPULOS

     President, National Defense Council Foundation, Alexandria, VA

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                             MARCH 30, 2006

                              ----------                              

    My name is Milton R. Copulos, and I am president of the 
National Defense Council Foundation.
    I would like to thank Chairman Lugar for giving me the 
opportunity to speak with the committee today and I would also 
like to commend him for his leadership addressing our nation's 
perilous energy dependence.

                     A HEADLONG RUSH INTO DISASTER

    America is rushing headlong into disaster. What is worse, 
however, is that it is a disaster of our own design.
    More than three decades have passed since the 1973 Arab Oil 
Embargo first alerted the nation to its growing oil import 
vulnerability. Yet, despite this warning, we are now importing 
more than twice as much oil in absolute terms than we did in 
1973, and the proportion of our oil supplies accounted for by 
imports is nearly double what is was then. What makes this 
dependence even more dangerous than it was three decades ago is 
the fact that the global market has become a far more 
competitive place with the emerging economies of China, India, 
and Eastern Europe creating burgeoning demand for increasingly 
scarce resources.
    Indeed, over the past decade the Chinese economy has grown 
at a frenetic pace, officially estimated at 9.2 percent in 
2005. India's growth rate for that year was 7.1 percent. In 
Eastern Europe, Belarus grew at 7.8 percent, the Czech Republic 
at 4.6 percent, and the Ukraine at 4.4 percent. This compares 
with 3.5 percent for the United States, 2.1 percent for Japan, 
and 1.7 percent for the European Union.
    As a result of this explosive growth, oil consumption in 
the developing countries is expected to increase at a rate of 3 
percent annually over the next two decades. But even this 
figure may severely understate the problem. Indeed, China alone 
has accounted for 40 percent of the total increase in world oil 
consumption over the past several years. Moreover China plans 
to add 120 million vehicles to its automobile fleet over the 
next decade, ultimately requiring 11.7 million barrels per day 
of new crude oil supplies. India, too, is expected to continue 
to require increasingly large amounts of oil with a projected 
increase of 28 percent over just the next 5 years.
    Even conservative estimates suggest that nearly 30 million 
barrels per day of new oil supplies will be required by the 
year 2025 just to service the developing world's requirements. 
When Europe and the Americas are included the requirement is 
closer to 40 million barrels per day. It is doubtful that new 
supplies sufficient to meet this skyrocketing demand will be 
found from conventional sources.

                          UNCERTAIN SUPPLIERS

    Nor is it just the potential physical shortfall of 
resources that is a source of concern. An even greater concern 
lies in the instability of U.S. sources of oil imports.
    The top six sources of U.S. oil imports, Canada, Mexico, 
Saudi Arabia, Venezuela, Nigeria, and Iraq account for 65.1 
percent of all foreign crude reaching our shores and 38.9 
percent of total domestic consumption. Of these, four, Saudi 
Arabia, Venezuela, Nigeria, and Iraq provide 38.2 percent of 
oil imports and 22.6 percent of total consumption. For a 
variety of reasons, none of the four I just mentioned can be 
considered a reliable source of supply.Venezuela's President 
Hugo Chavez is a vocal opponent of the United States who has 
twice threatened to cut off oil shipments to the United States.
    Nigeria's production has been repeatedly disrupted by civil 
unrest, and some 135,000 barrels of oil per day are lost to 
theft.
    Last month, a terrorist attack on the massive Saudi oil 
processing facility at Abqaiq was barely thwarted, but not 
before two of the terrorist's explosive-laden cars were 
detonated. Moreover, this was not the only instance of an 
attempt to disrupt the flow of Saudi oil. In the summer of 
2002, Saudi Interior Ministry forces blocked an al-Qaeda plot 
to attack and cripple the loading dock at Ras Tanura which 
handles 10 percent of the world's oil supplies.
    Attacks on oil facilities in Iraq are a frequent 
occurrence.
    Nor are the attacks on U.S. oil supplies a coincidence. In 
December of 2004, al-Qaeda issued a fatwa that said in part:

          We call on the mujahideen in the Arabian Peninsula to 
        unify their ranks and target the oil supplies that do 
        not serve the Islamic nation but the enemies of this 
        nation.

    The fatwa went onto declare:

          Be active and prevent them from getting hold of our 
        oil and concentrate on it particularly in Iraq and the 
        Gulf.

    Clearly, given the instability that characterizes four of 
our top six sources of oil, the question is not whether we will 
experience a supply disruption, but rather when. The disruption 
could occur as a consequence of a terrorist act, or could 
result from a politically motivated embargo. In the end, it 
doesn't really matter why a disruption occurs, because the 
consequences would be identical, and severe.

                     THE CONSEQUENCES OF DISRUPTION

    The supply disruptions of the 1970s cost the U.S. economy 
between $2.3 trillion and $2.5 trillion. Today, such an event 
could carry a price tag as high as $8 trillion--a figure equal 
to 62.5 percent of our annual GDP or nearly $27,000 for every 
man, woman, and child living in America.
    But there is more cause for concern over such an event than 
just the economic toll. A supply disruption of significant 
magnitude, such as would occur should Saudi supplies be 
interdicted, would also dramatically undermine the nation's 
ability to defend itself.
    Oil has long been a vital military commodity, but today has 
taken on even more critical importance. Several examples 
illustrate this point:

   A contemporary U.S. Army Heavy Division uses more 
        than twice as much oil on a daily basis as an entire 
        World War II field army.

   The roughly 582,000 troops dispatched to the Persian 
        Gulf used more than twice as much oil on a daily basis 
        as the entire 2-million man Allied Expeditionary Force 
        that liberated Europe in World War II.

   In Operation Iraqi Freedom, the oil requirement for 
        our Armed Forces was 20 percent higher than in the 
        first gulf war, Operation Desert Storm, and now amount 
        to one barrel of refined petroleum products per day for 
        each deployed service member.

    Moreover, the military's oil requirements will be even 
higher in the future.
    Therefore, a shortage of global oil supplies not only holds 
the potential to devastate our economy, but could hamstring our 
armed forces as well.

                    THE HIDDEN COST OF IMPORTED OIL

    While it is broadly acknowledged that our undue dependence 
on imported oil would pose a threat to the nation's economic 
and military security in the event of a supply disruption, less 
well understood is the enormous economic toll that dependence 
takes on a daily basis.
    The principal reason why we are not fully aware of the true 
economic cost of our import dependence is that it largely takes 
the form of what economists call ``externalities,'' that is, 
costs or benefits caused by production or consumption of a 
specific item, but not reflected in its pricing. It is 
important to understand that even though external costs or 
benefits may not be reflected in the price of an item, they 
nonetheless are real.
    In October 2003, my organization, The National Defense 
Council Foundation, issued ``America's Achilles Heel: The 
Hidden Costs of Imported Oil,'' a comprehensive analysis of the 
external costs of imported oil. The study entailed the review 
of literally hundreds of thousands of pages of documents, 
including the entire order of battle of America's Armed Forces 
and more than a year of effort. Its conclusions into divided 
the externalities into three basic categories: Direct and 
Indirect economic costs, Oil Supply Disruption Impacts, and 
Military Expenditures.
    Taken together, these costs totaled $304.9 billion 
annually, the equivalent of adding $3.68 to the price of a 
gallon of gasoline imported from the Persian Gulf.
    As high as these costs were, however, they were based on a 
crude oil refiner acquisition cost of $26.92. Today, crude oil 
prices are hovering around $60 per barrel and could easily 
increase significantly. Indeed, whereas in 2003 we spent around 
$99 billion to purchase foreign crude oil and refined petroleum 
products, in 2005 we spent more than $251 billion, and this 
year we will spend at least $320 billion.
    But skyrocketing crude oil prices were not the only factor 
affecting oil-related externalities. Defense expenditures also 
changed.
    In 2003, our Armed Forces allocated $49.1 billion annually 
to maintaining the capability to assure the flow of oil from 
the Persian Gulf.
    I should note that expenditures for this purpose are not 
new. Indeed, last year marked the 60th anniversary of the 
historic meeting between Saudi monarch King Abdul Aziz and U.S. 
President Franklin Roosevelt where he first committed our 
nation to assuring the flow of Persian Gulf oil--a promise that 
has been reaffirmed by every succeeding President, without 
regard to party.
    In 1983 the implicit promise to protect Persian Gulf oil 
supplies became an explicit element of U.S. military doctrine 
with the creation of the United States Central Command, 
CENTCOM. CENTCOM's official history makes this clear stating in 
part:

          Today's command evolved as a practical solution to 
        the problem of projecting U.S. military power to the 
        gulf region from halfway around the world.

    I am stressing the longstanding nature of our commitment to 
the gulf to underscore the fact that our estimates of military 
expenditures there are not intended as a criticism. Quite the 
opposite, in fact. Without oil our economy could not function, 
and therefore protecting our sources of oil is a legitimate 
defense mission, and the current military operation in Iraq is 
part of that mission.
    To date, supplemental appropriations for the Iraq War come 
to more than $251 billion, or an average of $83.7 billion per 
year. As a result, when other costs are included, the total 
military expenditures related to oil now total $132.7 billion 
annually.
    So, where does that leave us?
    In 2003, as noted, we estimated that the ``hidden cost'' of 
imported oil totaled $304.9 billion. When we revisited the 
external costs, taking into account the higher prices for crude 
oil and increased defense expenditures we found that the 
``hidden cost'' had skyrocketed to $779.5 billion in 2005. That 
would be equivalent to adding $4.10 to the price of a gallon of 
gasoline if amortized over the total volume of imports. For 
Persian Gulf imports, because of the enormous military costs 
associated with the region, the ``hidden cost'' was equal to 
adding $7.41 cents to the price of a gallon of gasoline. When 
the nominal cost is combined with this figure it yields a 
``true'' cost of $9.53 per gallon, but that is just the start.
    Because the price of crude oil is expected to remain the 
$60 range this year, expenditures for imports are expected to 
be at least $320 billion this year. That amounts to an increase 
of $70 billion in spending for foreign oil in just one year. 
That increase would raise the total import premium or ``hidden 
cost'' to $825.1 billion, or almost twice the President's 
$419.3 billion defense budget request for fiscal year 2006. If 
all costs are amortized over the total volume of imports, that 
would be equivalent to adding $5.04 to the price of a gallon of 
gasoline. For Persian Gulf imports, the premium would be $8.35. 
This would bring the ``real'' price of a gallon of gasoline 
refined from Persian Gulf oil to $10.86. At these prices the 
``real'' cost of filling up a family sedan is $217.20, and 
filling up a large SUV $325.80.
    But, can anything be done about this enormous drain on our 
economy? The answer to that question is, ``yes.''

                          SOLVING THE PROBLEM

    The simple truth is that we do not suffer from a lack of 
energy resources. Rather, what we suffer from is a lack of the 
political will and public consensus to use them.
    As Pogo said, ``We have met the enemy and they is us.''
    What then can we do?
    The first step is to recognize that we face a two-fold 
problem. The first part entails assuring adequate fuel supplies 
for the 220 million privately owned vehicles on the road today. 
These vehicles have an average lifespan of 16.8 years and the 
average age of our vehicle fleet is 8.5 years. Therefore, we 
will require conventional fuels or their analogs for at least a 
decade, even if every new vehicle produced from this day forth 
runs on some alternative.
    The second part of the problem is how to affect a 
transition to alternatives to conventional petroleum. This 
transition will take much longer than a decade--perhaps a 
generation or more--but the longer we delay beginning to make 
the change, the longer it will take to accomplish.
    In the near term, say the next 5 to 10 years, we 
essentially have two options. First, to make the greatest 
possible use of our readily accessible conventional domestic 
resources, particularly the oil and natural gas that lay off 
our shores. We should also consider using some of our 1,430 
trillion cubic feet of domestic gas reserves as a feedstock for 
motor fuels produced through the Fischer-Tropsch process. 
Indeed, we currently have 104 trillion cubic feet of so-called 
``stranded'' natural gas in Alaska and a pipeline with some 1.1 
million barrels per day of excess capacity. Stranded gas could 
be converted into clean burning motor fuel and transported in 
the existing pipeline to the lower 48 states.
    We can also expand our use of renewable fuels such as 
alcohol and biodiesel. A concerted program to make full use of 
them could significantly add to our motor fuel stocks within 
the stated time frame.
    We should also encourage the acquisition of advanced 
vehicle technologies such as flex-fuel vehicles, hybrids and 
plug-in hybrids and vehicles that use propane or natural gas. 
At the same time, we should encourage the installation of 
biodiesel and E-85 pumps in our nation's filling stations so 
that the infrastructure for alternative fuels can keep pace 
with the growth of the alternative fuel vehicle fleet.
    Another point is to make sure that we do not forget to 
address nontransportation petroleum consumption. The fact that 
two-thirds of our petroleum is consumed in the transportation 
sector means that one-third is not. The opportunities to reduce 
oil consumption from nontransportation are greater than you 
might expect.
    Take residential energy use for example. Roughly 12 percent 
of distillate use goes to home heating, most of it imported 
from the Middle East. Yet, there are alternatives readily 
available that could totally eliminate this use, and at the 
same time save consumers money. For instance, a developer in 
Moline, IL, is currently building homes that are between 85 
percent and 90 percent energy efficient, and meet their heating 
and cooling requirements with geothermal energy. More 
important, these homes are being sold for 20 percent less than 
conventional housing sold in the same area. So consumers are 
not only saving energy, they are saving enormous amounts of 
money.
    There is another commercial process that converts waste 
wood into a zero-sulfur industrial boiler fuel. Our Clean 
Forests program that removes dead wood and debris from national 
forests to prevent fires is generating an enormous amount of 
such waste wood, and that is just the tip of the iceberg. Oak 
Ridge National Laboratory estimates that a total of 1.366 
billion tons of biomass is available for energy production each 
year. Utilizing this process, it could be turned into 5.6 
million barrels of oil per day, or close to 27 percent of our 
total domestic requirements.
    These, of course, are just two examples. Many more exist. 
The important consideration is that we have a wealth of options 
that could help in the near to intermediate term if we would 
only make use of them. To do this, however, we must have 
leadership.
    In this regard, I should note that Chairman Lugar and his 
colleagues, Senators Chaffee, Coleman, Nelson, and Obama, 
deserve particular praise for their sponsorship of S. 2025, the 
Vehicle and Fuel Choices for American Security Act, which is 
based on the Energy Security Blueprint of the Set America Free 
Coalition, of which I was a founding member. It is focused on 
reducing our dependence on foreign oil, not by compromising the 
American way of life, but by encouraging fuel choice, 
utilization of the vast array of America's domestic energy 
resources and accelerated deployment of advanced vehicle 
technologies. It is clear that this sort of bipartisan effort 
is exactly the kind of action that is required if we are to 
make any progress on this critical issue.
    In the longer term, there are other domestic energy 
resources that can be brought into play. We have between 500 
billion and 1.1 trillion barrels of oil contained in our huge 
oil shale resources. We have 496.1 billion tons of demonstrated 
coal reserves--27 percent of the world total. We also have 
320,222 trillion cubic feet of natural gas in the form of 
methane hydrates. This is equivalent to 51.1 trillion barrels 
of oil. Indeed one on-shore deposit in Alaska alone contains 
519 trillion cubic feet of natural gas. That is equal to 82.9 
billion barrels of oil.
    We also have 4.85 billion pounds of uranium reserves. 
Harnessing this vital resource to provide electricity for our 
cities, towns, and farms is only common sense. Moreover, it 
could serve to reduce the need to use natural gas for 
electricity generation, preserving it for higher uses.
    There is one final point I want to make sure is not 
forgotten. Some portion of every dollar we spend on imported 
oil finds its way into the hands of individuals who wish to do 
us harm. The simple truth is that international terrorism 
stands on two financial pillars: Oil and the drug trade. To the 
extent that we reduce the revenues generated by either of these 
activities, we hinder the ability of terrorists to operate.
    To conclude, while we our nation is in dire peril due to 
its excessive dependence on imported oil, the situation is far 
from hopeless. We have the resources necessary to provide our 
nation's energy needs if we can only find the political will to 
do so.

                           Prepared Statement

                         DR. HILLARD HUNTINGTON

    Executive Director, Energy Modeling Forum, Stanford University, 
                              Stanford, CA

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                             MARCH 30, 2006

                              ----------                              

    Thank you, Chairman Lugar, Ranking Member Biden, and 
distinguished members of the committee, for the opportunity to 
discuss with you today the hidden cost of oil.
    Tight oil markets with minimal surplus capacity have made 
world oil prices particularly jumpy over recent months. In the 
last 6 months, a series of political and natural events have 
cascaded around the globe and left their impact on increasingly 
nervous oil-consuming nations. These developments have been 
extremely varied and include the following:

   A thwarted suicide attack in February at the Abqaiq 
        oil processing facility in eastern Saudi Arabia;

   A string of turmoil in the Niger Delta highlighted 
        by a recent speedboat attack in January by gunmen on 
        the riverside offices of Italian oil company Agip;

   Antigovernment attempts to disrupt congressional 
        elections in Venezuela culminating in an explosion at 
        an oil pipeline connected to that country's largest oil 
        refinery; and

   Devastating hurricanes Katrina and Rita in the 
        United States in August and September.

    Their sporadic nature conveys an element of 
unpredictability and surprise.
    I have recently coordinated several studies for the Energy 
Modeling Forum at Stanford University that relate directly to 
this issue. I would like to share a few observations that I 
think summarize the perspectives of many (but certainly not 
all) participants who were involved in the studies. Our forum 
frequently brings together the leading experts and advisors 
from government, business, and university and other research 
organizations to discuss how we can improve analysis of key 
energy problems that keep policymakers awake at night. In this 
particular case, the work was done primarily for the U.S. 
Department of Energy, but we were asked to invite individuals 
we thought were the leading people on this issue.
    Our two studies focused on the risks of another major oil 
disruption and the economic consequences of oil price shocks. I 
am also submitting both reports that expand considerably over 
my brief remarks here today. I will also briefly discuss a 
third issue: Our dependence on the oil-producing cartel.
    Although these episodes have made oil-importing countries 
nervous and have imposed some very high costs on people and 
infrastructure, they have yet to duplicate the types of oil 
shocks that were experienced during the 1970s and early 1990s. 
As a result, their economic impacts have been more tolerable 
than in the past. Despite recent oil price volatility, for 
example, real GDP in the United States has grown strongly, by 
3.5 percent annually since the end of 2001.
    A number of knowledgeable experts, however, are concerned 
about the very real possibility of much more damaging shocks in 
the future. A group assembled by Stanford's EMF thought that 
the odds of, at least, one very damaging shock over the next 10 
years were higher than those of an oil market with some 
volatility but without such a shock. Although another major oil 
disruption is not a certainty, its likelihood is significantly 
high enough to be worrisome.
    Your odds of drawing a club, diamond, or heart from a 
shuffled deck of playing cards are three out of four. In the 
EMF study, the participants found that the odds of a foreign 
oil disruption happening over the next 10 years are slightly 
higher at 80 percent. Disruption events included surprise 
geopolitical, military, or terrorist turmoil that would remove 
at least 2 million barrels per day--an amount representing 
about 2.1 percent of expected global oil production. Foreign 
disruptions of this magnitude would have more serious effects 
on oil prices and the economy than we have seen with the 
Katrina and Rita hurricanes. Oil prices, however, would rise 
more and for longer than a few months or a heating season.
    In the study, experts estimated the amount of oil lost to 
the market as the number of barrels removed by the initial 
disruption, minus any offsets from the use of excess capacity 
from undisrupted regions. The experts were asked to exclude any 
releases from the U.S. strategic petroleum reserve, as these 
actions require separate decisions from the government during 
an emergency.
    The approach identified four major supply regions where 
disruptions are most likely. These regions account for 
approximately similar shares of total world oil production. 
Collectively, they account for about 60 percent of total world 
oil production. The study lumped Algeria, Angola, Libya, 
Mexico, Nigeria, and Venezuela as the first region, called 
``West of Suez.'' Saudi Arabia was the second region, and other 
Persian Gulf states--Iran, Iraq, Kuwait, Qatar, UAE, and Oman-- 
were the third. Russia and the Caspian states comprised the 
fourth region.
    The riskiest areas were the Persian Gulf countries outside 
of Saudi Arabia and several countries along the Atlantic Basin, 
such as Nigeria and Venezuela. The least risky area was Russia 
and the Caspian states. Although the participants found the 
possibility of disruptions was lower in Saudi Arabia than in 
several other vulnerable regions, disruptions there would tend 
to have larger effects.
    In the second study on the economic consequences of a major 
disruption, we sought to understand how easily the economy 
could absorb such a shock. Figure 1 shows that oil price shocks 
preceded 9 of the last 10 recessions in the United States. The 
solid line indicates the path of inflation-adjusted crude oil 
prices since 1950. The gray bars denote periods when the U.S. 
economy was experiencing recessions as defined by the National 
Bureau of Economic Research (NBER). This finding was first 
advanced by Professor James Hamilton at University of 
California at San Diego and has been confirmed by numerous 
other researchers.
    If a large disruption does occur, we can expect very 
serious economic consequences. Large disruptions, especially if 
they move inflation-adjusted oil prices higher than experienced 
recently, will cause unemployment and excess capacity to grow 
in certain key sectors. Many large-scale models of the U.S. 
economy estimate that the level of real GDP could decline by 2 
percent for a doubling of oil prices. Since the economy is 
growing more rapidly than 2 percent per year, that impact would 
not mean a recession.
    Other researchers, however, think that these estimates 
underestimate the impacts, because they do not focus explicitly 
on sudden and scary oil price shocks. These other researchers 
think that our historical experience suggests that the level of 
real GNP would decline by more, at 5 percent for a doubling of 
the oil price. My personal view is that the higher estimate may 
be closer to what would actually happen if we had a major 
disruption. That would mean a recession.
    Some people think that oil shocks may not be a problem 
because the Federal Reserve Board could intervene and lessen 
the impact. I have a great deal of faith in the Federal Reserve 
Board. They have done a marvelous job in controlling inflation, 
which places the U.S. economy in a better position for 
offsetting oil disruptions than in previous decades. I am not 
yet convinced that they can compensate the economy for a large 
devastating disruption. They would have to make some important 
decisions very quickly at a time when fears were running 
rampant. They may also find it difficult to stimulate the 
economy because nominal interest rates are already very low, 
not only here but also abroad. For this reason, I think that 
the United States should seriously consider other types of 
insurance policies that would allow the Federal Reserve Board 
more leeway and flexibility in controlling our inflation rates.
    As a general rule, strategies that reduce our dependence on 
oil consumption are more effective than policies that reduce 
our imports. One should view the world oil market as one giant 
pool rather than as a series of disconnected puddles. When 
events happen anywhere in the market, they will raise prices 
not only there but also everywhere that connect to that large 
pool. Since reducing our imports with our own production does 
not sever our link to that giant pool, disruptions will cause 
prices to rise for all production, including that originating 
in the United States. More domestic supplies do not protect us 
from these price shocks.
    Unfortunately, insurance policies are never free. It will 
cost us something to implement a strategy that reduces our risk 
to another major oil disruption. But it will also cost us a lot 
of money and jobs if we do not adopt an insurance policy and 
the nation faces another major disruption.
    As a result of the 1970 oil price shocks, we shifted away 
from oil in many sectors in the early 1980s, but that trend has 
slowed considerably since then. Moreover, transportation 
remains strongly tied to oil use. The dependence on oil in 
transportation not only affects households directly through 
higher gasoline costs but it also raises the costs of 
transporting goods around the country.
    Our most recent studies did not address a third issue that 
could influence the costs of using oil. It is sometimes argued 
that the United States could adopt policies that would try to 
minimize or break the oil-producing cartel's control over the 
market. Our forum addressed this issue many years ago. Although 
the range of views was wide, our working group conservatively 
estimated that the hidden cost of oil from this source might be 
$5 per barrel, or 12 cents per gallon. Several years ago, the 
National Research Council used a very similar estimate in their 
review of the corporate average fuel economy standards for 
automobiles. That estimate is not trivial, but it is 
considerably smaller than various estimates for gasoline's 
hidden costs due to pollution, congestion and automobile 
accidents.
    In summary, the nation is vulnerable to another major 
disruption not because the economy imports oil but primarily 
because it uses a lot of oil, primarily for gasoline and jet 
fuel. Even if domestic production could replace all oil 
imports, which I am not advocating, the economy would remain 
vulnerable to the types of disruptions discussed here. However, 
it is very appropriate that this committee focus its energy on 
this issue. Oil-importing governments have committed 
significant political and military resources to the Middle East 
over a number of decades in order to provide regional stability 
that is critical to world oil supplies. Excessive exposure to 
oil vulnerability risks in this country increases these costs 
or reduces the capacity to pursue foreign policy objectives 
that are critical for mitigating nuclear proliferation, 
terrorism, and other risks that reduce global security. I 
cannot provide you with an estimate for this political cost of 
using oil, but it is extremely important.

                           Prepared Statement

                            DR. GARY W. YOHE

John E. Andrus Professor of Economics, Wesleyan University, Middletown, 
                                   CT

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                             MARCH 30, 2006

                              ----------                              

    Mr. Chairman, Senator Biden, and members of the Committee 
on Foreign Relations, thank you for your invitation to present 
testimony in on ``The Hidden (Climate Change) Costs of Oil''. 
It is indeed an honor to be here, today.
    The task that I accepted when I agreed to testify involves 
providing some insight into the economic cost of carbon 
emissions so that you can ``back out the share of oil to get 
the right order of magnitude.'' I am afraid, however, that this 
deceptively complicated question has the same answer as nearly 
every other question in economics: ``It depends.'' My testimony 
will therefore be directed at providing insight into the 
underlying factors upon which these costs depend. I will, 
however, also offer some thoughts about what the underlying 
uncertainty means for climate policy and the hidden cost of 
oil.
    I will begin with a brief review of the range of more than 
100 published estimates of what is termed the ``social cost of 
carbon''; this is the calculation by which we can attribute a 
share of cost to oil based on its carbon content (per unit 
energy). I will highlight why the range of these estimates is 
so large. I will suggest which of the factors that make the 
range so large can be influenced by political decisionmakers, 
but I will also focus attention on scientific factors that are 
beyond their control. Thinking about how we should cope with 
these scientific factors will lead me to identify two 
fundamental sources of hidden cost that may not be immediately 
obvious.
    I will, in particular, suggest an alternative way to 
calculate the hidden climate costs of oil based explicitly on 
hedging against the potentially severe economic costs of abrupt 
changes in policy. These policy adjustments may be required 
over the near to moderate term as we come to know more about 
the impacts and/or likelihoods of climate change (particularly 
abrupt climate change). It is important to recognize that many 
of these impacts have not yet been included in the direct 
calculation of social cost. Adopting a risk-management 
(hedging) approach to minimize the cost of future policy 
adjustments is therefore an appropriate, economically rational 
way to think about the social cost of carbon. Moreover, it 
makes uncertainty a reason to act immediately rather than a 
reason to procrastinate.
    I will, as well, argue that ignoring social costs 
calculated by either a tradition direct method or one derived 
from a risk-management approach systematically undervalues 
projects and programs that would reduce our consumption of 
petroleum (like investment in ethanol as an alternative source 
of energy) while it produces an symmetric overvaluation of 
projects and programs that would do just the opposite (like 
drilling in the Arctic National Wildlife Refuge).
    To begin, I recall ``burning ember'' diagram from the Third 
Assessment Report (the TAR) of the Intergovernmental Panel on 
Climate Change (2001) in Figure 1. It duplicates Figure TS-12 
from the Technical Summary of the Third Assessment Report where 
five Lines of Evidence'' were identified. These are the five 
sources of concern, or indicators of vulnerability, that have 
captured our attention. Two are essentially economic indicators 
of aggregate impacts at the global and regional levels. They 
are dominated by estimates of the costs of the climate impacts 
in market-based sectors like real estate (in response to rising 
seas), agricultural, energy, and the like. As such, they do 
include evaluations of how various nations and even communities 
within nations might adapt to climate-related stress. It is 
important to recognize, of course, that these impacts are felt 
unevenly across the globe. Panel A of Figure 2 offers a 
representative portrait of a possible geographic distribution 
of vulnerability to climate impacts in 2050 calibrated in terms 
of aggregate impacts. Developing countries show up as most 
vulnerable, but developed countries are surely not immune to 
climate risk even when their superior capacities to adapt are 
recognized.
    A third row in Figure 1 focuses attention squarely on 
ecosystems, although the IPCC did not provide the detailed 
assessment of ecosystem services that was so thoroughly 
documented in the recently completed Millennium Ecosystem 
Assessment. The last two rows reflect vulnerability to two 
potentially more significant areas concern: ``Risks from Future 
Large-Scale Discontinuities'' and ``Risks from Extreme Weather 
Events''. Figure 2 illustrates the uneven impact point by 
displaying a plausible global distribution of vulnerability in 
2050 calibrated to the risks of extreme weather events. 
Developing countries are still most vulnerable, but developed 
countries also face significant vulnerabilities from a more 
urgent ``source of concern.''
    Economists have been trying for some time to assign 
currency values to the impacts of climate change identified in 
Figure 1 by tracking their potential trajectories along long-
term scenarios of how the future might unfold. Not 
surprisingly, economists do not agree on what that future might 
hold. They do, however, agree on what measure to use: ``The 
social cost of carbon.'' What is that? It is the damage caused 
over time by releasing an addition unit of ton of carbon in the 
atmosphere discounted back to the year of its emission. That is 
to say, the social cost of carbon represents the ``marginal 
cost'' of emissions; alternatively, it represents the 
``marginal benefit'' of unit of carbon emissions reduction. 
Most importantly for present purposes, the social cost of 
carbon, when modified by the carbon content of petroleum, is 
the hidden (climate change) cost of oil.
    Figure 3 displays the range of more than 100 estimates 
currently available in the published literature; it is derived 
from Tol (2005). Panel A of Figure 3 displays the social cost 
in dollars per metric ton of carbon; Panel B tracks the 
estimate to the hidden cost of oil by expressing social cost in 
dollars per barrel of oil.
    How should the data portrayed in Figure 3 be read? 
Percentile values are recorded up the vertical axis for cost 
estimates ordered from lowest to highest. So, for example, 
point A indicates that 12 percent of the published estimates 
were below $0. Point B highlights the median estimate, 
suggesting that 50 percent of the estimates were below $13 per 
ton of carbon ($2 per barrel of oil), and 50 percent of the 
estimate were above this benchmark. Point C shows that 20 
percent of the estimates were above $73 per ton of carbon ($9 
per barrel of oil). Finally, the average across all of the 
published estimates is $85 per ton ($11 per barrel of oil).
    How should the content of Figure 3 be read, given all of 
the disagreement that it reveals? Richard Tol, an economist 
from Germany, read the data to mean that $45 per ton should be 
interpreted as the upper bound for a reasonable ``best'' 
estimate of the social cost of carbon; this is $6 per barrel of 
oil. Thomas Downing (2005), a geographer from the Stockholm 
Environment Institute office in the United Kingdom looked at 
the same distribution through the lens of enormous experience 
in developing countries where changes in climate produce 
enormous displacement effects that cannot be quantified in 
terms of currencies. He read the data to mean that $45 per ton 
or $6 per barrel of oil should be interpreted as a lower bound 
to the true social cost of carbon.
    I have been told that presenting such a figure in a 
political environment would allow people who do not think that 
climate is a problem to focus on the lower part of range and 
people who think that climate is a large problem to focus on 
the upper part of the range. Productive conversations between 
the two sides, I have also been told, would seldom be a product 
of such readings.
    For this, and a few other reasons, I now preach caution to 
all. To appropriately read Figure 3, we must work to understand 
what is going on behind the scenes. Why is the range so large? 
Which of the ``Lines of Evidence'' do the estimates include, 
and which do they miss? What combinations of underlying factors 
produce low or even negative estimates of social cost, and what 
other combinations support estimates on the high end of the 
scale? Answers to these questions can be enormously revealing.
    The choice of discount rate and the incorporation of equity 
weights are extremely important, and both lie within the 
purview of decisionmakers. High discount rates sustain low 
estimates because future damages become insignificant. 
Conversely, low discount rates produce high estimates because 
future damages are important. Meanwhile, strong equity 
weighting across the globe support high estimates because poor 
developing countries are most vulnerable. Conversely, weak or 
no equity weighting can produce low estimates because poor 
developing countries do not factor heavily in the overall 
calculation.
    It turns out, however, that several scientific parameters 
that decisionmakers cannot choose are even more important in 
explaining the variability depicted in Figure 3. Indeed, 
climate sensitivity (i.e., the increase in global mean 
temperature that would result from a doubling of greenhouse gas 
concentrations from preindustrial levels) is the largest source 
of variation. It is possible to derive high estimates for the 
social cost of carbon even if you assume low discount rates and 
almost no equity weighting. All that is required is the 
assumption that the climate sensitivity lies at the high range 
of the latest range of estimates. Andronova and Schlesinger 
(2001), for example, find that the historical record could 
easily be explained with climate sensitivities as high as 8 or 
9 degrees Centigrade (even though the TAR reported an upper 
bound of 5.5 degrees).
    Moreover, none of the estimates from which Figure 3 was 
drawn include the economic costs of ``Risks from Extreme 
Climate Events'' or ``Risks from Future Large-Scale 
Discontinuities.''
    To offer one glimpse at the role that these sources of 
concern might play, I can report the results of some more 
recent work that focuses on what we know about when the 
Atlantic thermohaline circulation (the Gulf Stream when it 
flows close to the United States) might weaken or suddenly 
collapse. Schlesinger, et al. (2006) put the chance of collapse 
at 50 percent if the global mean temperature were to climb by 
another 2 degrees Centigrade. Put another way, Yohe, et al. 
(2006) show more than a 40 percent chance of collapse by 2105 
along a ``middle of the road'' emissions scenario. Imposing a 
global policy targeted at a $100 per ton social cost of carbon 
($12 per barrel of oil) would reduce that likelihood to 25 
percent if it were initiated immediately; but only to 35 
percent if it were delayed by 30 years.
    At this point, it is essential to re-emphasize the point 
that none of these critical scientific factors can be decided 
by committee deliberation and popular elections. Their values 
are up to nature to decide, and we simply do not know what she 
has in the cards for us. The bottom-line is that the planet 
faces significant risks whose economic impacts have not yet 
been quantified. We have some idea of their likelihood, though, 
and so it is impossible to claim with certainty that they will 
not materialize as the future unfolds.
    What should we do? We should recognize that the climate 
policy will be adjusted over time as we learn more, especially 
if all (or even one) of the really bad news scenarios begin to 
materialize. We should also recognize that these adjustments 
could significantly and immediately change the economic 
environment in which we will be living. Moreover, we should 
recognize that these adjustments might be required sooner 
rather than later.
    All of this risk in the policy realm suggests an 
alternative method for estimating the social cost of carbon. 
Yohe, et al. (2004) conducted a simple ``act-then-learn'' 
experiment which showed that the expected discounted cost of 
global policy adjustment in 2035 could be minimized if a modest 
hedging policy were begun now. Their work suggests a risk-based 
social cost of carbon in 2005 equal to about $10 per ton ($1.50 
per barrel of oil). And their approach makes uncertainty is the 
reason to act in the near term rather than a reason to delay.
    To be clear, tacking on $1.50 to the price of a barrel of 
oil will not do the trick. This risk based social cost would 
increase over time at the rate of interest. So it would be $3 
per barrel in 2020 and $5 per barrel just after 2030. The 
critical component of the policy, and this estimate of social 
cost, is not the starting point. Consistent with the 
observation by Watkiss, et al. (2005) that the traditionally 
computed social cost of carbon increases over time, it is the 
persistent and predictable ratcheting-up of the effective price 
of carbon that would give the hedging strategy any traction at 
all.
    This observation brings me to my last point--identifying a 
second potentially expensive consequence of ignoring the hidden 
climate cost of oil. Failing to include estimates of the social 
cost of the carbon content of oil simply makes projects that 
use more oil or provide more oil more likely to go forward. 
Why? Because the calculations upon which the investment 
decisions would be made would inappropriately underestimate 
true costs. They would, in other words, show exaggerated 
benefit-cost ratios because the denominators would be too low. 
Conversely, failing to include the social cost of the carbon 
content of oil makes projects that conserve oil or provide 
alternative sources of energy less likely to go forward. They 
would simply show deflated benefit-cost ratios because the 
numerators would be too low.
    So, what if I had to pick a number? What would I say if 
asked to estimate place the hidden social cost of oil in 
perspective? I think that my $1.50 per barrel risk-based 
estimate is too low, since our analysis assumed immediate 
global participation in any policy response 2005 and it 
captured only a very limited set of possible sources of 
uncertainty. Given all of the impacts that are not yet part of 
the more traditional approaches, though, I do not think that 
the $6 per barrel estimate that separated Tol from Downing is 
too high. If pressed, I would probably say $5 per barrel for 
2006, but I could be just as comfortable with $10. Indeed, I 
would insist only that the social cost attributed to oil for 
its climate impacts increase over time at the real rate of 
interest.
    Again, thank you for the opportunity to be here today, and 
thank you for your attention.
                         ``HIGH COST OF CRUDE:

                  THE NEW CURRENCY OF FOREIGN POLICY''

                      Wednesday, November 16, 2006

                                ------                                

                           Opening Statement

                         HON. RICHARD G. LUGAR

                       U.S. Senator From Indiana,

            Chairman, Senate Committee on Foreign Relations

                              ----------                              

    The committee meets today to examine the effects of U.S. 
oil consumption on American foreign policy and on our wider 
economic and security interests. High oil prices have hurt 
American consumers at the gas pump, and record revenues flowing 
into oil producing nations are changing the world's 
geopolitical landscape. Increasingly, oil is the currency 
through which countries leverage their interests against oil 
dependent nations such as ours.
    Oil is not just another commodity. It occupies a position 
of singular importance in the American economy and way of life. 
In 2003, each American consumed about 25 barrels of oil. That 
is more than double the per capita consumption in the United 
Kingdom, Germany, and France and more than 15 times that of 
China. With less than 5 percent of the world's population, the 
United States consumes 25 percent of its oil.
    Higher oil prices have helped drive the consumer price 
index up 4.7 percent during the past year. Motorists felt this 
pinch at the pump long before the destruction of Hurricanes 
Katrina and Rita. This year, the United States has spent about 
$19 billion per month on oil imports. The cost of imported oil 
now accounts for approximately one-third of our trade deficit.
    In the short run, our dependence on oil has created a drag 
on economic performance at home and troubling national security 
burdens overseas. In the long run, this dependence is pushing 
the United States toward an economic disaster that could mean 
diminished living standards, increased risks of war, and 
accelerated environmental degradation.
    Up to this point, the main issues surrounding oil have been 
how much we have to pay for it and whether we will experience 
supply disruptions. But in decades to come, the issue may be 
whether the world's supply of oil is abundant and accessible 
enough to support continued economic growth, both in the 
industrialized West and in large rapidly growing economies like 
China and India. When we reach the point where the world's oil-
hungry economies are competing for insufficient supplies of 
energy, oil will become an even stronger magnet for conflict 
than it already is.
    Since 1991, we have fought two major wars in the oil-rich 
Middle East, and oil infrastructure and shipping lanes are 
targets for terrorism. In addition to the enormous dollar cost 
we pay for the military strength to maintain our access to 
foreign oil, our petroleum dependence exacts a high price in 
terms of foreign policy and international security.
    Massive infusions of oil revenue distort regional politics 
and can embolden leaders hostile to U.S. interests. Iran, where 
oil income has soared 30 percent this year, threatened last 
month to use oil as a weapon to protect its nuclear ambitions. 
At a time when the international community is attempting to 
persuade Iran to live up to its nonproliferation obligations, 
our economic leverage on Iran has declined due to its 
burgeoning oil revenues. Similarly, the Chavez government in 
Venezuela resists hemispheric calls for moderation, in part 
because it has been emboldened by growing oil revenues. Russia 
uses its gushing oil and natural gas income and reserves as 
leverage over new democracies in East Europe. Globally, 
critical international security goals, including countering 
nuclear weapons proliferation, supporting new democracies, and 
promoting sustainable development are at risk because of 
dependence on oil.
    Diversification of our supplies of conventional and 
nonconventional oil, such as Canada's tar sands, is necessary 
and under way. Yet because the oil market is globally 
integrated, the impact of this diversification is limited. Our 
current rate of oil consumption, coupled with rapidly 
increasing oil demand in China, India, and elsewhere, will 
leave us vulnerable to events in the tumultuous Middle East and 
to unreliable suppliers such as Venezuela. Any solution will 
require much more than a diversification and expansion of our 
oil supply.
    Despite the widening discussion of our energy 
vulnerability, the U.S. political system has been capable of 
only tentative remedial steps that have not disturbed the 
prevailing oil culture. The economic sacrifices imposed on 
Americans recently by rising oil prices have expanded our 
nation's concern about oil dependence. But in the past, as oil 
price shocks have receded, motivations for action have also 
waned. Currently, policies for mediating the negative effects 
of oil dependence continue to be hamstrung in debate between 
supply-side approaches and those preferring to decrease demand. 
We must consider whether the political will now exists to 
commit to a comprehensive strategy.
    Our weak response to our own energy vulnerability is all 
the more frustrating given that alternatives to oil do exist. 
Oil's importance is the result of industrial and consumption 
choices of the past. We now must choose a different path. 
Without eliminating oil imports or abandoning our cars, we can 
offset a significant portion of demand for oil by giving 
American consumers a real choice of automotive fuel. We must 
end oil's near monopoly on the transportation sector, which 
accounts for 60 percent of American oil consumption.
    I believe that biofuels, combined with hybrid and other 
technologies, can move us away from our extreme dependence on 
oil. Corn-based ethanol is already providing many Midwesterners 
with a lower cost fuel option. Cellulosic ethanol, which is 
made of more abundant and less expensive biomass, is poised for 
a commercial takeoff. We made progress in the 2005 energy bill, 
which includes incentives to produce 7.5 billion gallons of 
renewable biofuel annually. I introduced legislation last week 
that would require manufacturers to install flexible-fuel 
technology in all new cars. This is an easy and cheap 
modification, which allows vehicles to run on a mixture of 85 
percent ethanol and 15 percent gasoline.
    We will get even greater payoffs for our investment in oil 
alternatives if American technological advances can be marketed 
to the rest of the world. Nations containing about 85 percent 
of the world's population depend on oil imports. These nations 
could reap many of the same security and economic benefits by 
breaking their oil import chains. Developing countries could 
improve their balance of payments and promote rural development 
by growing profitable biomass, while offering new markets for 
fuel technologies.
    We need to think creatively about cooperating with other 
countries to address today's global energy challenges. For 
example, earlier this month I introduced S. 1950, ``The United 
States-India Energy Security Cooperation Act of 2005.'' This 
bill would promote greater cooperation with India on clean coal 
technology, ethanol, and other energy sources.
    I am particularly pleased to welcome two old friends, 
today, who will assist us in our inquiry today. Dr. James 
Schlesinger, former Secretary of Defense, Secretary of Energy, 
and Director of Central Intelligence, has seen America through 
oil shocks and has remained committed to improving America's 
energy situation. He is a keen analyst of the geopolitical 
consequences of oil dependence, as well as an authority on 
America's energy future.
    Also joining us is Mr. James Woolsey, former Director of 
Central Intelligence. In 1999, Jim and I--and I would stress my 
dependance on his tutelage in this--coauthored ``The New 
Petroleum,'' an article in Foreign Affairs that laid out the 
case for a greater role for cellulosic ethanol. He has 
continued to serve as a leading advocate for forward-looking 
reforms of our energy policy. We thank our distinguished 
witnesses for coming and look forward to their insights.

                           Prepared Statement

                         HON. JAMES SCHLESINGER

            Senior Advisor, Lehman Brothers, Washington, DC

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                           NOVEMBER 16, 2005

                              ----------                              

    Mr. Chairman, members of the committee, I thank the 
committee for this opportunity to discuss the quest for energy 
security, the implications of our heavy dependence on imported 
oil, the rise in oil prices, and their manifold political and 
economic repercussions for our nation. In so many ways, the use 
of oil as our primary energy source turns out to be a two-edged 
sword. Given that dependence, the ramifications are too 
numerous to discuss in detail. Given the necessary limitations 
on time, I must be selective. Therefore, I shall touch only 
upon several salient points.

    1. Mr. Chairman, the problem of energy security is of 
relatively recent origin. When mankind depended upon windmills, 
oxen, horses, etc., energy security was not a strategic 
problem. Instead, as a strategic problem it is a development of 
modem times--and reflects most crucially the turn to fossil 
fuels as increasingly the source of energy. The Industrial 
Revolution in the 19th century, strongly reinforced by the 
rapid growth of oil-dependent transportation in the 20th, 
unavoidably posed the question of security of supply. Imperial 
Germany took over Lorraine with its coal fields after the 
Franco-Prussian War--to insure its energy security. When 
Britain, pushed by Churchill, converted its Navy to oil early 
in the 20th century, it sought a secure supply of oil under its 
own control in the Persian Gulf--which incidentally increased 
its concern for the security of the Suez Canal. For the United 
States, where the production of oil had started and for long 
was primarily located, the question of security of supply did 
not arise until the 1960s and 1970s. Since then, we have 
regularly talked about--and sought by various measures--to 
achieve greater energy security. Such measures, limited as they 
were, have generally proved unsatisfactory. The nation's 
dependence on imported hydrocarbons has continued to surge.
    Mr. Chairman, until such time as new technologies, barely 
on the horizon, can wean us from our dependence on oil and gas, 
we shall continue to be plagued by energy insecurity. We shall 
not end dependence on imported oil nor, what is the hope of 
some, end dependence on the volatile Middle East--with all the 
political and economic consequences that flow from that 
reality. That is not to say that various measures and 
inventions will not, from time to time, shave our growing 
dependence, but we will not end it. Instead of energy security, 
we shall have to acknowledge and to live with various degrees 
of insecurity.
    To be sure, we have certain short-term problems to which I 
shall presently turn. More importantly, we face a fundamental, 
longer term problem. In the decades ahead, we do not know 
precisely when, we shall reach a point, a plateau or peak, 
beyond which we shall be unable further to increase production 
of conventional oil worldwide. We need to understand that 
problem now and to begin to prepare for that transition.
    The underlying problem is that for more than three decades, 
our production has outrun new discoveries. Most of our giant 
fields were found 40 years ago and more. Even today, the bulk 
of our production comes from these old--and aging--giant 
fields. More recent discoveries tend to be small with high 
decline rates--and are soon exhausted. Since the issue is 
crucial--and is not widely understood--I have prepared a chart 
which lays bare the problem.
    Mr. Chairman, the upshot is, quite simply, that, as the 
years roll by, the entire world will face a prospectively 
growing problem of energy supply. Moreover, we shall inevitably 
see a growing dependency on the volatile Middle East. We shall 
have to learn to live with degrees of insecurity--rather than 
the elusive security we have long sought. To be sure, some 
insecurity will be mitigated by the Strategic Petroleum 
Reserve, and other emergency measures. That will provide some 
protection against (short-term) supply disruptions, but it will 
not provide protection against the fundamental long-term 
problem.

    2. In addition to the long-term problem of the prospective 
limit on conventional oil production, we have a number of 
short-term or cyclical problems that have contributed to the 
current stringency and current high prices. Spare production 
capacity has essentially disappeared. This reflects the 
volatility of oil prices, which has led to a low rate of 
investment in new capacity, as well as an unexpected surge of 
demand, particularly from China and the United States. For many 
years, we have had excess capacity in refining. That, too, has 
largely disappeared, and we lack capacity to refine the heavy, 
sour crudes that remain available. Here in the United States, 
the problem has been amplified by the battering of gulf 
infrastructure by Hurricanes Katrina and Rita. We also have an 
added, self-inflicted problem of some 17 boutique blends of 
gasoline, mandated by state authorities.
    The insurgency in Iraq has prevented the increase in 
production, even to the prewar level, that many expected. Long-
term sanctions against Iraq, Iran, and Libya, both United 
States and international, have reduced their contribution to 
world supply. This has taken place against inelastic domestic 
production of natural gas. There are, in addition, problems of 
electric power generation and transmission. The point about all 
of these is these are not inherent problems. In principal, they 
would all yield to additional investment. Yet, we must bear in 
mind that investment activity depends upon price signals, and 
that there is a long period of gestation before additional 
investment activity brings supply to market. Some of these 
problems may, however, be ameliorated by changes in law or in 
regulation.
    By about 2010, we should see a significant increase in oil 
production as a result of investment activity now under way. 
There is a danger that any easing of the price of crude oil 
will, once again, dispel the recognition that there is a finite 
limit to conventional oil. In no way do the prospective 
investment decisions solve the long-term, fundamental problem 
of oil supply.

    3. Let me turn now to the political and economic 
ramifications. Again, let me underscore that energy actions 
tend to be a two-edged sword. To some extent, the recent higher 
prices for oil reflect some of our own prior policies and 
actions. For example, the sanctions imposed upon various rogue 
nations, by reducing world supply, have resulted in higher 
prices. Operation Iraqi Freedom, followed by the insurgency, 
has caused unrest in the Middle East. The consequence has been 
somewhat lower production and a significant risk premium that, 
again, has raised the price of oil.
    The effect of higher oil prices has been significantly 
higher incomes for producers. A much higher level of income has 
meant that a range of nations, including Russia, Iran, 
Venezuela, as well as gulf Arab nations have had their economic 
problems substantially eased. As a result, they have become 
less amenable to American policy initiatives. Perhaps more 
importantly, the flow of funds into the Middle East inevitably 
has added to the moneys that can be transferred to terrorists. 
As long as the motivation is there and controls remain 
inadequate, that means that the terrorists will continue to be 
adequately or amply funded. To the extent that we begin to run 
into supply limitations and to the extent that we all grow more 
dependent on the Middle East, this problem of spillover funding 
benefits for terrorists is not going to go away.

    4. There are, of course, additional problems of an economic 
nature. We all understand that higher oil prices can depress 
spending on other goods and services--and thereby cause slower 
growth rates and possibly a worldwide recession. The reverse 
side of rising receipts for producers is, of course, rising 
out-payments by consumer nations. This can readily augment 
structural imbalances. This year, the American balance-of-
payments deficit looks to be almost three-quarters of a 
trillion dollars. That is not small change. Of the well over 
$700 billion of that deficit, some $300 billion comes from oil 
and gas. It is recognized that the U.S. balance-of-payments 
deficit represents the locomotive that drives much of the 
world's economies. In performing this service--for which we get 
little thanks--the United States is steadily adding to its 
financial obligations to others. How long this process can 
continue is uncertain, but high oil prices add to the dilemma.
    Finally, Mr. Chairman, I must point to another problem. The 
United States is today the preponderant military power in the 
world. Still, our military establishment is heavily dependent 
upon oil. At a minimum, the rising oil price poses a budgetary 
problem for the Department of Defense at a time that our 
national budget is increasingly strained. Moreover, in the 
longer run, as we face the prospect of a plateau in which we 
are no longer able, worldwide, to increase the production of 
oil against presumably still-rising demand, the question is 
whether the Department of Defense will still be able to obtain 
the supply of oil products necessary for maintaining our 
military preponderance. In that prospective world, the 
Department of Defense will face all sorts of pressures at home 
and abroad to curtail its use of petroleum products, thereby 
endangering its overall military effectiveness.
    In closing, Mr. Chairman, I trust that I have fulfilled the 
request in your letter of invitation to analyze ``the 
complexity of U.S. reliance on imported energy sources, 
particularly oil, and the difficulties the United States faces 
in mediating detrimental effects of this dependency.'' Even in 
the short run, actions that we take may substantially increase 
the resources and reduce the economic and political pressures 
on states that are hostile to us. In the longer run, unless we 
take serious steps to prepare for the day that we can no longer 
increase production of conventional oil, we are faced with the 
possibility of a major economic shock--and the political unrest 
that would ensue. The United States has just over 4 percent of 
the world's population and uses roughly 25 percent of the 
world's oil production. In a sense, this statistic in itself is 
misleading, because the United States produces roughly 20 to 25 
percent of the gross world product. Nonetheless, that statistic 
does underscore our potential vulnerability in an era that we 
may no longer be able to produce additional conventional crude 
oil worldwide.
    Thank you very much, Mr. Chairman. I shall be happy to 
answer any questions that you or the members of the committee 
may have.

                           Prepared Statement

                         HON. R. JAMES WOOLSEY

            Vice President, Booz Allen Hamilton, McClean, VA

                               BEFORE THE

               U.S. Senate Committee on Foreign Relations

                           NOVEMBER 16, 2005

                              ----------                              

    Mr. Chairman and members of the committee, it's a real 
pleasure to appear before this committee today on this issue. I 
am appearing solely on my own behalf and represent no 
organization. By way of identification I served as Director of 
Central Intelligence, 1993-95, one of the four Presidential 
appointments I have held in two Republican and two Democratic 
administrations; these have been interspersed in a career that 
has been generally in the private practice of law and now in 
consulting. The substantial majority of the points I will make 
today are drawn from an August 2005 paper by former Secretary 
of State, George P. Shultz, and myself, although I have updated 
some points due to more recent work; the two of us are 
cochairmen of the Committee on the Present Danger and the full 
paper may be found at the committee's Web site 
(www.fightingterror.org).
    Just over 4 years ago, on the eve of 9/11, the need to 
reduce radically our reliance on oil was not clear to many and 
in any case the path of doing so seemed a long and difficult 
one. Today both assumptions are being undermined by the risks 
of the post-9/11 world, by oil prices, and by technological 
progress in fuel efficiency and alternative fuels.
    There are at least seven major reasons why dependence on 
petroleum and its products for the lion's share of the world's 
transportation fuel creates special dangers in our time. These 
dangers are all driven by rigidities and potential 
vulnerabilities that have become serious problems because of 
the geopolitical realities of the early 21st century. Those who 
reason about these issues solely on the basis of abstract 
economic models that are designed to ignore such geopolitical 
realities will find much to disagree with in what follows. 
Although such models have utility in assessing the importance 
of more or less purely economic factors in the long run, as 
Lord Keynes famously remarked: ``In the long run, we are all 
dead.''
    These dangers in turn give rise to two proposed directions 
for government policy in order to reduce our vulnerability 
rapidly. In both cases it is important that existing technology 
should be used, i.e., technology that is already in the market 
or can be so in the very near future and that is compatible 
with the existing transportation infrastructure. To this end 
government policies in the United States and other oil-
importing countries should: (1) Encourage a shift to 
substantially more fuel-efficient vehicles within the existing 
transportation infrastructure, including promoting both battery 
development and a market for existing battery types for plug-in 
hybrid vehicles; and (2) encourage biofuels and other 
alternative and renewable fuels that can be produced from 
inexpensive and widely available feedstocks--wherever possible 
from waste products.

                   PETROLEUM DEPENDENCE: THE DANGERS

1. The current transportation infrastructure is committed to oil and 
        oil-compatible products
    This fact substantially increases the difficulty of 
responding to oil price increases or disruptions in supply by 
substituting other fuels.
    There is a range of fuels that can be used to produce 
electricity and heat and that can be used for other industrial 
uses, but petroleum and its products dominate the fuel market 
for vehicular transportation. With the important exception, 
described below, of a plug-in version of the hybrid gasoline/
electric vehicle, which will allow recharging hybrids from the 
electricity grid, substituting other fuels for petroleum in the 
vehicle fleet as a whole has generally required major, time-
consuming, and expensive infrastructure changes. One exception 
has been some use of liquid natural gas (LNG) and other fuels 
for fleets of buses or delivery vehicles, although not 
substantially for privately owned ones, and the use of corn-
derived ethanol mixed with gasoline in proportions up to 10 
percent ethanol (``gasohol'') in some States. Neither has 
appreciably affected petroleum's dominance of the 
transportation fuel market.
    Moreover, in the 1970s about 20 percent of our electricity 
was made from oil--so shifting electricity generation toward, 
say, renewables or nuclear power could save oil. But since 
today only about 3 percent of our electricity is oil-generated, 
a shift in the way we produce electricity would have almost no 
effect on the transportation or oil market. This could change 
over the long run, however, with the advent of plug-in hybrid 
vehicles, discussed below.
    There are imaginative proposals for transitioning to other 
fuels for transportation, such as hydrogen to power automotive 
fuel cells, but this would require major infrastructure 
investment and restructuring. If privately owned fuel cell 
vehicles were to be capable of being readily refueled, this 
would require reformers (equipment capable of reforming, say, 
natural gas into hydrogen) to be located at filling stations, 
and would also require natural gas to be available there as a 
hydrogen feed-stock. So not only would fuel cell development 
and technology for storing hydrogen on vehicles need to be 
further developed, but the automobile industry's development 
and production of fuel cells also would need to be coordinated 
with the energy industry's deployment of reformers and the fuel 
for them.
    Moving toward automotive fuel cells thus requires us to 
face a huge question of pace and coordination of large-scale 
changes by both the automotive and energy industries. This 
poses a sort of industrial Alphonse and Gaston dilemma: Who 
goes through the door first? (If, instead, it were decided that 
existing fuels such as gasoline were to be reformed into 
hydrogen on board vehicles instead of at filling stations, this 
would require onboard reformers to be developed and added to 
the fuel cell vehicles themselves--a very substantial 
undertaking.)
    It is because of such complications that the National 
Commission on Energy Policy concluded in its December 2004, 
report ``Ending The Energy Stalemate'' that ``hydrogen offers 
little to no potential to improve oil security and reduce 
climate change risks in the next 20 years.''
    To have an impact on our vulnerabilities within the next 
decade or two, any competitor of oil-derived fuels will need to 
be compatible with the existing energy infrastructure and 
require only modest additions or amendments to it.
2. The Greater Middle East will continue to be the low-cost and 
        dominant petroleum producer for the foreseeable future
    Home of around two-thirds of the world's proven reserves of 
conventional oil--45 percent of it in just Saudi Arabia, Iraq, 
and Iran--the Greater Middle East will inevitably have to meet 
a growing percentage of world oil demand. This demand is 
expected to increase by more than 50 percent in the next two 
decades, from 78 million barrels per day (bbl/d) in 2002 to 118 
bbl/d in 2025, according to the Federal Energy Information 
Administration. Much of this will come from expected demand 
growth in China and India. One need not argue that world oil 
production has peaked to see that this puts substantial strain 
on the global oil system. It will mean higher prices and 
potential supply disruptions and will put considerable leverage 
in the hands of governments in the Greater Middle East as well 
as in those of other oil-exporting states which have not been 
marked recently by stability and certainty: Russia, Venezuela, 
and Nigeria, for example. Deep-water drilling and other 
opportunities for increases in supply of conventional oil may 
provide important increases in supply but are unlikely to 
change this basic picture.
    Even if other production comes on line, e.g., from 
unconventional sources such as tar sands in Alberta or shale in 
the American West, their relatively high cost of production 
could permit low-cost producers, particularly Saudi Arabia, to 
increase production, drop prices for a time, and undermine the 
economic viability of the higher cost competitors, as occurred 
in the mid-1980s. For the foreseeable future, as long as 
vehicular transportation is dominated by oil as it is today, 
the Greater Middle East, and especially Saudi Arabia, will 
remain in the driver's seat.
3. The petroleum infrastructure is highly vulnerable to terrorist and 
        other attacks
    The radical Islamist movement, including but not 
exclusively al-Qaeda, has on a number of occasions explicitly 
called for worldwide attacks on the petroleum infrastructure 
and has carried some out in the Greater Middle East. A more 
well-planned attack than what has occurred to date--such as 
that set out in the opening pages of Robert Baer's recent book, 
``Sleeping With the Devil'' (terrorists flying an aircraft into 
the unique sulfur-cleaning towers in northeastern Saudi 
Arabia), could take some 6 million barrels per day off the 
market for a year or more, sending petroleum prices sharply 
upward to well over $100/barrel and severely damaging much of 
the world's economy. Domestic infrastructure in the West is not 
immune from such disruption. U.S. refineries, for example, are 
concentrated in a few places, principally the gulf coast. The 
recent accident in the Texas City refinery--producing multiple 
fatalities--points out potential infrastructure 
vulnerabilities, as of course does this fall's hurricane damage 
in the gulf. The Trans-Alaska Pipeline has been subject to 
several amateurish attacks that have taken it briefly out of 
commission; a seriously planned attack on it could be far more 
devastating.
    In view of these overall infrastructure vulnerabilities 
policy should not focus exclusively on petroleum imports, 
although such infrastructure vulnerabilities are likely to be 
the most severe in the Greater Middle East. It is there that 
terrorists have the easiest access, and the largest proportion 
of proven oil reserves and low-cost production are also located 
there. Nor is anything particularly useful accomplished by 
changing trade patterns. To a first approximation there is one 
worldwide oil market and it is not generally useful for the 
United States, for example, to import less from the Greater 
Middle East and for others then to import more from there. In 
effect, all of us oil-importing countries are in this together.
4. The possibility exists, particularly under regimes that could come 
        to power in the Greater Middle East, of embargoes or other 
        disruptions of supply
    It is often said that whoever governs the oil-rich nations 
of the Greater Middle East will need to sell their oil. This is 
not true, however, if the rulers choose to try to live, for 
most purposes, in the seventh century. Bin Laden has advocated, 
for example, major reductions in oil production and oil prices 
of $200/barrel or more.
    In 1979 there was a serious attempted coup in Saudi Arabia. 
Much of what the outside world saw was the seizure by Islamist 
fanatics of the Great Mosque in Mecca, but the effort was more 
widespread. Even if one is optimistic that democracy and the 
rule of law will spread in the Greater Middle East and that 
this will lead after a time to more peaceful and stable 
societies there, it is undeniable that there is substantial 
risk that for some time the region will be characterized by 
chaotic change and unpredictable governmental behavior. Reform, 
particularly if it is hesitant, has in a number of cases been 
trumped by radical takeovers (Jacobins, Bolsheviks). There is 
no reason to believe that the Greater Middle East is immune 
from these sorts of historic risks.
5. Wealth transfers from oil have been used, and continue to be used, 
        to fund terrorism and its ideological support
    Estimates of the amount spent by the Saudis in the last 30 
years spreading Wahhabi beliefs throughout the world vary from 
$70 billion to $100 billion. Furthermore, some oil-rich 
families of the Greater Middle East fund terrorist groups 
directly. The spread of Wahhabi doctrine--fanatically hostile 
to Shiite and Suffi Muslims, Jews, Christians, women, 
modernity, and much else--plays a major role with respect to 
Islamist terrorist groups: A role similar to that played by 
angry German nationalism with respect to Nazism in the decades 
after World War I. Not all angry German nationalists became 
Nazis and not all those schooled in Wahhabi beliefs become 
terrorists, but in each case the broader doctrine of hatred has 
provided the soil in which the particular totalitarian movement 
has grown. Whether in lectures in the madrassas of Pakistan, in 
textbooks printed by Wahhabis for Indonesian schoolchildren, or 
on bookshelves of mosques in the United States, the hatred 
spread by Wahhabis and funded by oil is evident and 
influential.
    On all points except allegiance to the Saudi State, Wahhabi 
and al-Qaeda beliefs are essentially the same. In this there is 
another rough parallel to the 1930s--between Wahhabis' 
attitudes toward al-Qaeda and like-minded Salafist jihadi 
groups today and Stalinists' attitude toward Trotskyites some 
60 years ago. The only difference between Stalinists and 
Trotskyites was on the question whether allegiance to a single 
state was required or whether free-lance killing of enemies was 
permitted. But Stalinist hatred of Trotskyites and their free-
lancing didn't signify disagreement about underlying 
objectives, only tactics, and Wahhabi/Saudi cooperation with us 
in the fight against al-Qaeda doesn't indicate fundamental 
disagreement between Wahhabis and al-Qaeda on, e.g., their 
common genocidal fanaticism about Shi'a, Jews, and homosexuals. 
So Wahhabi teaching basically supports al-Qaeda ideology.
    It is sometimes contended that we should not seek 
substitutes for oil because disruption of the flow of funds to 
the Greater Middle East could further radicalize the population 
of some states there. The solution, however, surely lies in 
helping these states diversify their economies over time, not 
in perpetually acquiescing to the economic rent they collect 
from oil exports and to the uses to which these revenues are 
put.
6. The current account deficits for a number of countries create risks 
        ranging from major world economic disruption to deepening 
        poverty, and could be substantial reduced by reducing oil 
        imports
    The United States in essence borrows about $2 billion a 
day, every day, principally now from major Asian states, to 
finance its consumption. The single largest category of imports 
is the approximately $1 billion per working day borrowed to 
import oil. The accumulating debt increases the risk of a 
flight from the dollar or major increases in interest rates. 
Any such development could have major negative economic 
consequences for both the United States and its trading 
partners.
    For developing nations, the service of debt is a major 
factor in their continued poverty. For many, debt is heavily 
driven by the need to import oil that at today's oil prices 
cannot be paid for by sales of agricultural products, textiles, 
and other typical developing nation exports.
    If such deficits are to be reduced, however, say by 
domestic production of substitutes for petroleum, this should 
be based on recognition of real economic value such as waste 
cleanup, soil replenishment, or other tangible benefits.
7. Global-warming gas emissions from man-made sources create at least 
        the risk of climate change
    Although the point is not universally accepted, the weight 
of scientific opinion suggests that global warming gases 
produced by human activity form one important component of 
potential climate change. Oil products used in transportation 
provide a major share of U.S. man-made global warming gas 
emissions.

                  THREE PROPOSED DIRECTIONS FOR POLICY

    The above considerations suggest that government policies 
with respect to the vehicular transportation market should 
point in the following directions:
1. Encourage improved vehicle mileage, using technology now in 
        production
    Three currently available technologies stand out to improve 
vehicle mileage.
            Diesels
    First, modern diesel vehicles are coming to be capable of 
meeting rigorous emission standards (such as Tier 2 standards, 
being introduced into the United States, 2004-08). In this 
context it is possible without compromising environmental 
standards to take advantage of diesels' substantial mileage 
advantage over gasoline-fueled internal combustion engines.
    Substantial penetration of diesels into the private vehicle 
market in Europe is one major reason why the average fleet 
mileage of such new vehicles is 42 miles per gallon in Europe 
and only 24 mpg in the United States. Although the United 
States has, since 1981, increased vehicle weight by 24 percent 
and horsepower by 93 percent, it has actually somewhat lost 
ground with respect to mileage over that near-quarter century, 
In the 12 years from 1975 to 1987, however, the United States 
improved the mileage of new vehicles from 15 to 26 mpg.
            Hybrid gasoline-electric
    Second, hybrid gasoline-electric vehicles now on the market 
show substantial fuel savings over their conventional 
counterparts. The National Commission on Energy Policy found 
that for the four hybrids on the market in December 2004 that 
had exact counterpart models with conventional gasoline 
engines, not only were mileage advantages quite significant 
(10-15 mpg) for the hybrids, but in each case the horsepower of 
the hybrid was higher than the horsepower of the conventional 
vehicle.
            Light-weight carbon composite construction
    Third, constructing vehicles with inexpensive versions of 
the carbon fiber composites that have been used for years for 
aircraft construction can substantially reduce vehicle weight 
and increase fuel efficiency while at the same time making the 
vehicle considerably safer than with current construction 
materials. This is set forth thoroughly in the 2004 report of 
the Rocky Mountain Institute's ``Winning the Oil Endgame.'' 
Aerodynamic design can have major importance as well. This 
breaks the traditional tie between size and safety. Much 
lighter vehicles, large or small, can be substantially more 
fuel-efficient and also safer. Such composite use has already 
been used for automotive construction in Formula 1 race cars 
and is now being adopted by BMW and other automobile companies. 
The goal is mass-produced vehicles with 80 percent of the 
performance of hand-layup aerospace composites at 20 percent of 
the cost. Such construction is expected to approximately double 
the efficiency of a normal hybrid vehicle without increasing 
manufacturing cost.
2. Encourage the commercialization of alternative transportation fuels 
        that can be available soon, are compatible with existing 
        infrastructure, and can be derived from waste or otherwise 
        produced cheaply
            Biomass (cellulosic) ethanol
    The use of ethanol produced from corn in the United States 
and sugar cane in Brazil has given birth to the 
commercialization of an alternative fuel that is coming to show 
substantial promise, particularly as new feedstocks are 
developed. Some 6 million vehicles in the United States, and 
all new vehicles in Brazil other than those that use solely 
ethanol, are capable of using ethanol in mixtures of up to 85 
percent ethanol and 15 percent gasoline (E-85). These are 
called Flexible Fuel Vehicles (FFV) and require, compared to 
conventional vehicles, only a somewhat different kind of 
material for the fuel line and a differently programmed 
computer chip. The cost of incorporating this feature in new 
vehicles is trivial. Also, there are no large-scale changes in 
infrastructure required for ethanol use. It may be shipped in 
tank cars (and, in Brazil, in pipelines), and mixing it with 
gasoline is a simple matter.
    Although human beings have been producing ethanol, grain 
alcohol, from sugar and starch for millennia, it is only in 
recent years that the genetic engineering of biocatalysts has 
made possible such production from the hemicellulose and 
cellulose that constitute the substantial majority of the 
material in most plants. The genetically engineered material is 
in the biocatalyst only; there is no need for genetically 
modified plants.
    These developments may be compared in importance to the 
invention of thermal and catalytic cracking of petroleum in the 
first decades of the 20th century--processes which made it 
possible to use a very large share of petroleum to make 
gasoline rather than the tiny share that was available at the 
beginning of the century. For example, with such genetically 
engineered biocatalysts it is not only grains of corn but corn 
cobs and most of the rest of the corn plant that may be used to 
make ethanol.
    Such biomass, or cellulosic, ethanol is now likely to see 
commercial production begin first in a facility of the Canadian 
company, Iogen, with backing from Shell Oil, at a cost of 
around $1.30/gallon. The National Renewable Energy Laboratory 
estimates costs will drop to around $1.07/gallon over the next 
5 years, and the Energy Commission estimates a drop in costs to 
67-77 cents/gallon when the process is fully mature. The most 
common feedstocks will likely be agricultural wastes, such as 
rice straw, or natural grasses such as switchgrass, a variety 
of prairie grass that is often planted on soil bank land to 
replenish the soil's fertility. There will be decided financial 
advantages in using as feedstocks any wastes which carry a 
tipping fee (a negative cost) to finance disposal--e.g., waste 
paper, or rice straw, which cannot be left in the fields after 
harvest because of its silicon content.
    Old or misstated data are sometimes cited for the 
proposition that huge amounts of land would have to be 
introduced into cultivation or taken away from food production 
in order to have such biomass available for cellulosic ethanol 
production. This is incorrect. The National Commission on 
Energy Policy reported in December that, if fleet mileage in 
the United States rises to 40 mpg--somewhat below the current 
European Union fleet average for new vehicles of 42 mpg and 
well below the current Japanese average of 47 mpg--then as 
switchgrass yields improve modestly to around 10 tons/acre it 
would take only 30 million acres of land to produce sufficient 
cellulosic ethanol to fuel half the U.S. passenger fleet. By 
way of calibration, this would essentially eliminate the need 
for oil imports for passenger vehicle fuel and would require 
only the amount of land now in the soil bank (the Conservation 
Reserve Program (CRP) on which such soil-restoring crops as 
switchgrass are already being grown. Practically speaking, one 
would probably use for ethanol production only a little over 
half of the soil bank lands and add to this some portion of the 
plants now grown as animal feed crops (for example, on the 70 
million acres that now grow soybeans for animal feed). In 
short, the United States and many other countries should easily 
find sufficient land available for enough energy crop 
cultivation to make a substantial dent in oil use.
    There is also a common and erroneous impression that 
ethanol generally requires as much energy to produce as one 
obtains from using it and that its use does not substantially 
reduce global warming gas emissions. The production and use of 
ethanol merely recycles in a different way the CO2 that has 
been fixed by plants in the photosynthesis process. It does not 
release carbon that would otherwise stay stored underground, as 
occurs with fossil fuel use, but when starch, such as corn, is 
used for ethanol production much energy, including fossil-fuel 
energy, is consumed in the process of fertilizing, plowing, and 
harvesting. Even starch-based ethanol, however, does reduce 
greenhouse gas emissions by around 30 percent. Because so 
little energy is required to cultivate crops such as 
switchgrass for cellulosic ethanol production, and because 
electricity can be coproduced using the residues of such 
cellulosic fuel production, reductions in greenhouse gas 
emissions for celluslosic ethanol when compared to gasoline are 
greater than 100 percent. The production and use of cellulosic 
ethanol is, in other words, a carbon sink.
            Biodiesel and renewable diesel
    The National Commission on Energy Policy pointed out some 
of the problems with most current biodiesel ``produced from 
rapeseed, soybean, and other vegetable oils--as well as . . . 
used cooking oils.'' It said that these are ``unlikely to 
become economic on a large scale'' and that they could ``cause 
problems when used in blends higher than 20 percent in older 
diesel engines.'' It added that ``waste oil is likely to 
contain impurities that give rise of undesirable emissions.''
    The Commission notes, however, that biodiesel is generally 
``compatible with existing distribution infrastructure'' and 
outlines the potential of a newer process (``thermal 
depolymerization'') that produces renewable diesel without the 
above disadvantages, from ``animal offal, agricultural 
residues, municipal solid waste, sewage, and old tires.'' (This 
has recently been designated ``Renewable Diesel'' in the Energy 
Act of this past summer.) The Commission points to the current 
use of this process at a Conagra turkey processing facility in 
Carthage, Missouri, where a ``20 million commercial-scale 
facility'' is beginning to convert turkey offal into ``a 
variety of useful products, from fertilizer to low-sulfur 
diesel fuel'' at a potential average cost of ``about 72 cents 
per gallon.''
            Other Alternative Fuels
    Progress has been made in recent years on utilizing not 
only coal but slag from strip mines, via gasification, for 
conversion into diesel fuel using a modern version of the 
gasified-coal-to-diesel process used in Germany during World 
War II.
    Qatar has begun a large-scale process of converting natural 
gas to diesel fuel.
    Outside the realm of conventional oil, the tar sands of 
Alberta and the oil shale of the Western United States exist in 
huge deposits, the exploitation of which is currently costly 
and accompanied by major environmental difficulties, but both 
definitely hold promise for a substantial increase in oil 
supply.
3. Plug-in hybrids and battery improvements
    A modification to hybrids could permit them to become 
``plug-in-hybrids,'' drawing power from the electricity grid at 
night and using all electricity for short trips before they 
move to operating in their gasoline-electric mode as hybrids. 
With a plug-in hybrid vehicle one has the advantage of an 
electric car, but not the disadvantage. Electric cars cannot be 
recharged if their batteries run down at some spot away from 
electric power. But since all hybrids have tanks containing 
liquid fuel plug-in hybrids have no such disadvantage.
    The ``vast majority of the most fuel-hungry trips are under 
6 miles'' and ``well within the range'' of current (nickel-
metal hydride) batteries' capacity, according to Huber and 
Mills (``The Bottomless Well,'' 2005). Current Toyota Priuses 
sold in Japan and Europe have a button, that Toyota has removed 
for some reason on American vehicles, that permits all-electric 
driving for up to a kilometer; all that is really needed is to 
equip hybrids with adequate batteries so that this capability 
can be extended. Over half of all U.S. vehicles are driven less 
than 30 miles/day, so a plug-in hybrid that can obtain that 
range might go for many weeks without visiting the gasoline 
station. Other experts, however, emphasize that whether with 
existing nickel-metal-hydride battery types or with the more 
capable lithium-ion batteries now commercially available for 
computer and other applications, it is important that any 
battery used in a plug-in hybrid be capable of taking daily 
charging without being damaged and be capable of powering the 
vehicle at an adequate speed and argue that battery development 
will be necessary in order for this to be the case.
    But the California experience with electric vehicles (EVs) 
in the 1990s suggests otherwise. It demonstrated that batteries 
used in those vehicles, particularly the nickel-metal-hydride 
ones that were used in later EV models (some of which are still 
on the road), have easily shown the capability for being 
charged daily for a number of years. And at U. Cal. (Davis) 
Professor Andy Frank has been designing and operating plug-in 
hybrids for years that now, with commercially available 
batteries, operate all electrically for 60 miles at up to 60 
mph before the hybrid gasoline-electric feature needs to be 
used. Whether development is needed for some improvements to 
lithium-ion batteries or only financial incentives for mass 
production of them or the more mature nickel-metal-hydride 
batteries, such efforts should have the highest priority 
because plug-in hybrids promise to revolutionize transportation 
economics and to have a dramatic effect on the problems caused 
by oil dependence.
    Moreover the attractiveness to the consumer of being able 
to use electricity from overnight charging for a substantial 
share of the day's driving is stunning. The average residential 
price of electricity in the United States is about 8.5 cents/
kwh, and many utilities sell off-peak power for 2-4 cents/kwh. 
When one takes into consideration the different efficiencies of 
liquid-fueled and electric propulsion, then where the rubber 
meets the road the cost of powering a plug-in hybrid with 
average-cost residential electricity would be about 40 percent 
of the cost of powering the same vehicle with today's 
approximately $2.50/gallon gasoline, or, said another way, for 
the consumer to be able to buy fuel in the form of electricity 
at the equivalent of $1/gallon gasoline. Using off-peak power 
would then equate to being able to buy 25-to-50 cent/gallon 
gasoline. Given the burdensome cost imposed by current fuel 
prices on commuters and others who need to drive substantial 
distances, the possibility of powering one's family vehicle 
with fuel that can cost as little as one-tenth of today's 
gasoline (in the U.S. market) should solve rapidly the question 
whether there would be public interest in and acceptability of 
plug-in hybrids.
    Although the use of off-peak power for plug-in hybrids 
should not require substantial new investments in electricity 
generation for some time (until millions of plug-ins are on the 
road), greater reliance on electricity for transportation 
should lead us to look particularly to the security of the 
electricity grid as well as the fuel we use to generate 
electricity. In the United States the 2002 report of the 
National Academies of Science, Engineering, and Medicine 
(``Making the Nation Safer'') emphasized particularly the need 
to improve the security of transformers and of the Supervisory 
Control and Data Acquisition (SCADA) systems in the face of 
terrorist threats. The National Commission on Energy Policy has 
seconded those concerns. With or without the advent of plug-in 
hybrids, these electricity grid vulnerabilities require urgent 
attention.

                               CONCLUSION

    The dangers from oil dependence in today's world require us 
both to look to ways to reduce demand for oil and to increase 
supply of transportation fuel by methods beyond the increase of 
oil production.
    The realistic opportunities for reducing demand soon 
suggest that government policies should encourage hybrid 
gasoline-electric vehicles, particularly the battery work 
needed to bring plug-in versions thereof to the market, and 
modern diesel technology. The realistic opportunities for 
increasing supply of transportation fuel soon suggest that 
government policies should encourage the commercialization of 
alternative fuels that can be used in the existing 
infrastructure: Cellulosic ethanol and biodiesel/renewable 
diesel. Both of these fuels could be introduced more quickly 
and efficiently if they achieve cost advantages from the 
utilization of waste products as feedstocks.
    The effects of these policies are multiplicative. All 
should be pursued since it is impossible to predict which will 
be fully successful or at what pace, even though all are today 
either beginning commercial production or are nearly to that 
point. The battery development for plug-in hybrids is of 
substantial importance and should for the time being replace 
the current r&d emphasis on automotive hydrogen fuel cells.
    If even one of these technologies is moved promptly into 
the market, the reduction in oil dependence could be 
substantial. If several begin to be successfully introduced 
into large-scale use, the reduction could be stunning. For 
example, a 50-mpg hybrid gasoline/electric vehicle, on the road 
today, if constructed from carbon composites would achieve 
around 100 mpg. If it were to operate on 85 percent cellulosic 
ethanol or a similar proportion of biodiesel or renewable 
diesel fuel, it would be achieving hundreds of miles per gallon 
of petroleum-derived fuel. If it were a plug-in version 
operating on either upgraded nickel-metal-hydride or newer 
lithium-ion batteries so that 30-mile trips or more could be 
undertaken on its overnight charge before it began utilizing 
liquid fuel at all, it could be obtaining in the range of 1,000 
mpg (of petroleum).
    A range of important objectives--economic, geopolitical, 
environmental--would be served by our embarking on such a path. 
Of greatest importance, we would be substantially more secure.

                                  
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