Domestic Energy: A Supply and Demand Primer

Before the financial crisis emerged as the chief economic issue in this election cycle, the political discussion had focused on the United States’ energy needs. Oil prices were for a period of time, almost at $150 a barrel , and prices at the pump seemed outrageous to many consumers who were used to paying between $1.00 and $2.00 for a gallon of gasoline.

Once the debate reached the forefront of public consciousness, the scope of discussion crept out of control. The debate cascaded into concerns about security (sources of supply), social welfare (heating needs in the winter), and environmental impact (carbon emissions and global warming). Thus, domestic energy policy was not only proved to be an issue which was top of mind for voters, but an incredibly complex issue to discuss and balance.

Alternative energy will not sufficiently close the gap between the country’s demand and the supply. Renewable energy and nuclear power, will only serve as means to reduce independence on natural gas, and only in the residential, commercial, and shrinking industrial sectors. The transportation sector has been driving energy demand, and this sector is petroleum intensive.

One solution to the problem is then to improve the global and domestic supply of oil. Any improvement in the domestic supply of petroleum will reduce the US’s reliance on imports, but it is unlikely to make a dent in global supply , and therefore will not translate into any price alleviation for consumers. Therefore, it is not a sustainable long-term solution.

The best method for fixing the imbalance is to reduce demand created by the transportation sector, but prior methods to improve efficiency and reduce demand have had mixed results. Both candidates have laid out policies to curb petroleum demand in the transportation sector: increased use of public transit, solar and electric cars, and more efficient batteries. These are the only measures which will solve the US’s energy needs by cutting reliance on imports as well as shift consumers over a source of energy which is not supply constrained, and therefore cheaper.

Below are some facts pulled from government sources to call out the data underlying these conclusions:

Demand:

According to the Energy Information Administration, from 1997-2007 energy consumption has grown by roughly 1% per year from 94.2 Q (quadrillion) BTU to 101.6 Q BTU. Fossil fuels (oil and coal) constitute the vast majority of consumption (~85%), which hasn’t changed over time. Meanwhile, nuclear power as a share of overall consumption has increased from 7.5% to 8.3% at the cost of renewable sources, which has gone from 7.6% to 6.7%.

Fossil fuels consumption consists primarily of petroleum, which constitutes 46.2% of the consumption in 2007, which is up from 44.7% of fossil fuel consumption in 1997. This share has come primarily from natural gas, which has gone from 28.9% to 27.4%.

In 2007, the residential sector consumed 21.4% of the energy, commercial consumed 18.1%, industrial consumed 31.8%, and transportation consumed 28.6%. This marks a dramatic change from 1997. During the last ten years, the industrial sector’s share of energy consumption has dropped by 540 bps as energy intensive manufacturing and industrial activities have become a smaller part of the US economy. The other sectors gained share relatively evenly during this time period reflecting an improvement in overall economic activity despite the drop in the industrial sector.

What is the net result of all of this? Commercial and residential energy consumption consists almost entirely of natural gas for heating premises and not petroleum. However, the transportation sector consists entirely of petroleum energy use: trucks, automobiles, and airplanes. Uses of coal or other fuels are insignificant in this particular sector.

The response to help keep energy prices and low and curb demand in these areas has been in the form of government mandated fuel standards. As shown by the data, this has largely worked. In aggregate, gallons of petroleum consumed per vehicle has held fairly steady since the late 1970s. Improvements in fuel rate (miles per gallon) have been eaten up by an increased mileage rate (miles per vehicle). Meanwhile, as reported by the Bureau of Transportation Statistics the number of registered motor vehicles has increased from 161.5M to 250.9M from 1980 to 2006, which implies an annual growth rate of 1.8%.

Supply:

Given these demand trends in energy, it is important to look at trends in supply in order to real understand where today’s energy concerns lie.

While overall consumption has grown at 1% from 1997-2007, domestic energy production as actually remained flat to slightly decline at -0.1%. Nuclear power has grown steadily over the last ten years at 2.5%, but it has been outweighed by declines in both fossil fuels and other renewable sources. This can be seen in shifts in the share of energy production. Nuclear power has gained 280 bps of share at the expense of both fossil fuels and renewable energy.

In order to plug the gap between energy supply and demand, the US has actually turned to imports. Net energy imports have gone from 21.8% of total consumption in 1997, to 28.8% of total consumption today, have grown at 3.5% during the last ten years.

Perhaps unsurprisingly, petroleum imports have led the way. Petroleum importation was 83.6% of gross energy imports in 2007, and is the backbone of the driver of the growth in energy imports. What is surprising, however, is that the mix of countries the US is importing petroleum from has actually not changed during the last ten years. The Persian Gulf has gone from supplying 17.3% of the total petroleum imports to 16.1%. OPEC import share has moved from 45% to 44.5%. Thus, while the US continues to rely on the same nation to provide it oil, the degree of dependence has increased over the last ten years.

Summary:

The facts indicate that the US economy has undergone a structural shift in which its reliance on fossil fuels, specifically petroleum, has continued to increase during the last ten years. The country has not been able to increase petroleum production, and has thus had to rely on imports to feed consumption.