September 29, 2008

Challenge for the Next President: Energy

Dear senators McCain and Obama:

When one of you is sworn in as the 44th President of the U.S. next Jan. 20, you will inherit many problems and an even greater number of challenges. U.S. competitiveness falls into the latter category.

Though we tend to compartmentalize things -- such as looking at Afghanistan, Iraq, the financial crisis, the environment, education, taxes, Medicare, Social Security, etc. as separate items -- action on every item on your agenda will be limited by America's ability to pay for them. This will be determined, absent even more borrowing, by the economy's performance. And how well the economy performs is at least partly a function of our competitiveness: how well U.S. companies fare in the global marketplace.

Because the economic landscape continually changes, that marketplace today is far different than it was when either of you set out in public service. U.S. companies today are not just competing with Japanese, Western European, and South Korean companies, but with rivals from all over the globe, even places we used to call "Third World." Nor are we competing merely for customers and market share. We are competing with everyone from everywhere for everything: customers, raw materials, natural resources, financing, knowledge, and even people. We call this new phenomenon globality.

"Natural Security" is a key issue I know you want to make sure that when you are President, the U.S. maintains its competitive leadership in the world of globality. To do that, you and the new Congress will have to address four key issues: energy, education, infrastructure, and productivity. In a series of columns, I will do so in the weeks ahead.

Like you, I have children and am concerned about the world they will face. I humbly offer my perspective because I want to help ensure that all of our children and grandchildren inherit an America that is competitive on the world stage -- second to none. I hope you and your advisers will consider these observations and recommendations in the spirit with which they are offered.

It's fair to say that few issues are more important to the long-term health and success of our businesses, economy, and country than weaning the U.S. from its dependence on foreign oil. We now pump hundreds of billions of petrodollars each year into the economies of foreign countries. For economic, national security, and "natural security" [e.g., global warming] reasons we've got to stop this reckless behavior. This isn't only something we can do, but something we must do. And it's one of those rare win-win combinations. By reducing our dependence on foreign oil -- and over the long term on fossil fuels in general, regardless of their source -- we not only achieve energy independence, but reduce pollution and global warming while creating American jobs.

Presidential Warnings Began With Nixon Unfortunately, our nation has held this conversation before. Every U.S. President since Richard M. Nixon has been beset by the energy demon. In 1973 under him, and in 1979 during Jimmy Carter's Presidency, the U.S. experienced its first two major oil shocks.

Both Carter and Nixon questioned our reliance on foreign energy. Calling the challenge we faced "the moral equivalence of war," Carter called for a new energy policy to wean the U.S. from its reliance on unreliable and unfriendly sources of oil. Presidents Ronald W. Reagan, Bill Clinton, George H. W. Bush, and George W. Bush have issued similar alarms.

Yet the situation has gotten worse. In 1970 we were importing only 23% of our oil. Today we're using far more oil overall, and importing more than 60% of it. To date, we have fought this "war" in name only -- without an agreed-upon national objective, without a strategy, without a commander-in-chief focused on victory, and without a dedicated budget. If we had started to work seriously on this in 1973 and continued to work on it for 35 years, the U.S. would control its own energy destiny today.

With energy needs ballooning in China and India, oil and other natural resources will be near the top of the list of the "everything" for which we will be competing. U.S. access to reliable and affordable energy will have a dramatic impact on our ability to contend and innovate in an increasingly challenging world.

Drilling for time Over the next several years, the right policies from Washington -- and the right leadership in the White House -- could make a huge difference. In staking out their respective sides, politicians have been doing the American people a disservice by portraying our energy decisions as "either/or" choices: Either we expand our use of nuclear and coal-based power and drill for more oil and gas in Alaska's Arctic National Wildlife Refuge [ANWR] and off the coast of the U.S. mainland [the apparent GOP formula], or we focus on developing alternative energy sources, such as wind, tidal, solar, geothermal, and on down the list [the apparent Democratic approach].

We need it all, so the decision cannot be "either/or." In the short run, drilling may be the best answer. Realistically, though, drilling would merely buy us time -- 10, 20 or, if we are lucky, 30 years. If we merely wait to act on finding further solutions until we have depleted the potential oil within our borders, we may find ourselves with no options.

In the long term we need to turn to "renewables." But this will require the development of technology and investment in distribution systems. Ironically, the United States can produce all the energy it will need far into the future -- perhaps in perpetuity -- right here.

A five-word energy blueprint Consider wind power. In 2007, for the third year in a row, the U.S. was the fastest-growing wind power market in the world. U.S. wind farms this year alone are expected to generate an estimated 48 billion kilowatt hours of electricity, just over 1% of the total. Many states and the federal government are working closely with utilities and wind turbine manufacturers to increase the amount of electric power generated by renewable sources [especially wind] to 20% of the total by 2030. True, the intermittent nature of wind power creates its own challenges, such as the need for storage and backup capacity, and transmission issues remain. To move forward, it is essential to extend production tax credits.

Other technologies also hold great promise -- and present their own challenges. Every year, a square mile of sun-baked desert receives the solar energy equivalent of nearly a million barrels of oil. The American Solar Energy Society, in a January 2008 report, estimated that concentrated solar power [CSP] in the U.S. Southwest alone could provide approximately seven times America's current electric capacity. Current economics make solar power more expensive than fossil-based alternatives, so production tax credits and subsidies need to be extended to ensure that learning-curve effects will drive the costs down to match those of traditional energy sources.

All of this can be done if we have the foresight to invest in our energy future and the resolve to make the investments. Energy independence is one of the keys to U.S. competitiveness in the new world of globality. But it won't happen overnight. We need a plan to make it happen. Such a plan can be summarized in the following five words: Commit, reduce, expand, create, and convert.


The President needs to set a firm goal: energy independence by 2025, for example. And he needs to use the political capital he has at the outset of his Administration -- and the power of the bully pulpit -- to get the American people on board.


This summer's $4-per-gallon gasoline price finally got our attention. Americans reduced their driving significantly. But as the price of oil settles back down closer to $100 per barrel -- and the price of gasoline also declines -- many will return to business as usual. It can't be business as usual. The real crisis is not over and will repeat at some time in the future. I would suggest a significant increase in the federal gasoline tax. It should be phased in over 10 years, the approximate lifespan of a new car.

In theory at least, most of the U.S. auto fleet turns over every decade. With a punitive tax staring them in the face, smart consumers will change their driving habits and switch to more fuel-efficient cars, including hybrids and models developed from such other emerging technologies as electric cars. Automakers will give consumers what they want, just as they gave us SUVs.

In the first year the tax might be a modest 25 cents per gallon; by year 10, when the vast majority of Americans will be driving new fuel-efficient alternative fuel cars, the tax might reach $4 per gallon. The revenues would be used to upgrade mass transit -- more routes, greater frequency, better service, and lower fares -- in areas where it makes sense; fund research into inexhaustible noncarbon energy technologies; subsidize investment in the new distribution systems that will be required, such as electricity transmission systems, hydrogen fueling stations, and battery-charging and -exchange locations; and provide relief to lower-income Americans, who may lack the wherewithal to trade in their old cars for newer, fuel-efficient models.

In effect, we would use money that would otherwise have left the country for oil to instead create new technologies, new industries, and new jobs at home. The tax will guarantee that gas prices remain high, which will ensure that businesses and consumers understand that there's no turning back -- and that investments they make in new products, technologies, and companies will provide a payback.


In the short-term, we need to increase investment in exploration and drilling for oil and gas, especially in areas where it can be extracted from tar sands and shale. We may need to use some of the gas tax to subsidize the early production of oil from shale. But the payoff could be huge, with an estimated 800 billion barrels of recoverable oil from shale in the western U.S. alone, according to U.S. Interior Dept. estimates. But even if oil explorers are successful beyond their wildest dreams, we must use that oil as a "bridge" to alternative sources of energy.


Creating alternative energy sources will be no simple matter. There will be a huge learning curve. The costs will be no less grand. The proper role of government is twofold: Support basic research, as it has done in such other areas as medical research, and subsidize -- perhaps through the tax code -- companies developing the new technologies.

With the government, in effect, helping to fund the learning curve -- that is, sharing some of the risk -- and with private investors confident that they will be able to capture the necessary profits from their investments in alternative energy, the process will move forward more quickly. The combination of large-scale production and the learning that comes from the experience of producing large volumes will drive costs down significantly, creating compelling profit opportunities for business.


We need to move the U.S. from a liquid-fuel-based economy to an alternative-energy-based one, most likely electricity. This conversion will require building new infrastructure, from power lines to handle the distribution of electricity produced from solar, wind, and water power, to battery-charging and -changing stations, as Israel is doing. It also means developing cars that can use electricity effectively -- ramping up research efforts in battery technology, for example.

Most of all, conversion will require all of us to look beyond ourselves. Energy independence should be the legacy we leave to future generations.

"change" can start with energy Regardless of which of you is chosen to serve as President, the U.S. will not be able to compete in the era of globality if we remain energy hostages. We've got to control our own destiny. Energy and destiny are joined at the hip. We need you to step up to this challenge -- one we are certain to win, if we decide we really want to.

You both are running as "change" candidates. Energy seems a good place to start. Energy is not, of course, the only thing in which we need to invest. We also need to invest in infrastructure, education, and productivity, topics I'll address in upcoming columns.

The author gratefully acknowledges the contributions of his colleagues from BCG's Energy practice in the preparation of this article, including Rick Peters, Brad van Tassel, and Ivan Marten.