What the Olympics Can Teach Us About the Price of Gas

04/25/2010 05:12 am ET | Updated May 25, 2011

Vancouver, Canada -- This is the first Olympic Winter Games conducted on snow that was brought to the slopes by diesel trucks and helicopters -- because not enough fell in British Columbia in the year of "Snowmageddon." (Remember, it always snows somewhere -- this is global warming, not District of Columbia warming.) It's also the first Winter Olympics that has featured athletes protesting the energy policies of the host nation -- i.e. Canada's increasing emphasis on the incredibly polluting process of producing crude oil from tar sands. Olympics and NHL hockey great Mike Richter warned that "We can't seriously combat global warming while getting fuel from the world's dirtiest source. Unless we act now to combat climate change, it could put an end to the winters we know and love." (The Sierra Club has launched a "Love Winter, Hate the Oil Sands" campaign.) And many Canadians have lamented that two major corporate sponsors of the games -- Petro-Canada and the Royal Bank of Canada -- are deeply complicit in oil-sands extraction.

But the oil sands controversy at the Olympics is an interesting window into the increasingly complex questions of how will the world move itself around, and what really is the future of oil anyway?

Is oil a scarce geologic commodity on the verge of hitting an effective production peak, and soaring in price as a result of resulting scarcity? That's what the founder of the Virgin Group, Sir Richard Branson, warned the UK government. He thinks the crunch will come within five years.  His opinion is shared by the CEOs of at least two oil companies, Total and Petrobras, even though recent oil finds by Petrobras are often cited by peak oil skeptics as evidence that no crisis is near.

Does such an oil crunch mean that even such economically and environmentally unattractive options as cooking a lot of tar sands to make a little bit of crude oil are our future? Will Canada's bet on tar sands (which, increasingly, is being shunned by oil companies like Shell) be presciently rescued by China and other Asian countries who understand that access to anything that can be converted to oil is the key to future economic security?

Or as oil (a cheap commodity that the world has never tried very hard to conserve) now becomes more expensive, will it be replaced not with second-rate oil substitutes like tar sands but instead with fundamentally different transportation fuels such as natural gas, biofuels, and, eventually, electricity? Is the real probability not peak oil, but peak oil demand? That's what Saudi Arabia's chief climate negotiator is warning his country, saying a leveling off of world demand for oil is "an alarm that we need to take more seriously."

To understand, let's take a closer look at tar sands. Basically, the tar sands process involves burning huge quantities of natural gas to heat the sands and drive off the relatively tiny percentage of hydrocarbons they contain. It takes about two tons of tar sands to produce a single barrel of oil. It also takes three barrels of water. The net result is not only the release of a great deal of CO2 -- five times as much as is required for conventional oil production -- but also the devastation of the surface area underneath which the sands lie. Already-proposed mining projects would strip peat soils and forests from some 35 million acres of Canada's boreal forests.

Tar sands are also economically marginal. Saudi Arabian crude costs $3 to $4 to pump. Tar sands become economically viable only at oil prices in excess of $60 barrel. There are few other commodities with such a wide range for the cost of commercially viable production.

So we are wasting huge quantities of the cleanest fossil fuel -- natural gas -- and what will be the world's scarcest natural resource -- clean water -- to produce very expensive gasoline, while simultaneously dumping huge quantities of carbon into the atmosphere not only from burning the gas and tar sands oil but also from destroying the forests and peat soils. Basic economics suggests that this cannot make sense. But it appears to. Investors make money (sometimes). Why?

The fundamental reality that creates a market for tar sands is that global demand for oil is very inelastic. As the price goes up, those who need gasoline, jet fuel, or diesel have no realistic substitutes, so they must pay whatever the market demand. Economically marginal sources such as tar sands become profitable, while low-cost producers like the Saudis make enormous margins. Meanwhile, the economies of nations that import oil are devastated.

Why is demand inelastic? The answer is surprisingly simple. To use less oil requires either more-efficient transportation systems or different fuels. Both of those require major, long-term investments of capital -- in, say, vehicles powered with either natural gas or electricity. Whenever such investments have begun, a slump in the world price of oil has dried up their potential market and scared off investors. Tar sands production can be ramped up or slowed down much more quickly than new auto or truck fleets can be designed, built, and sold.

It is not that replacing oil is too expensive in the long run -- it is that it is too uncertain in the short run.

Some, like New York Times columnist Tom Friedman, even argue that such oil price dips are a conscious strategy by oil producers to ensure that alternatives to oil such as electrification or shifting goods transport from trucks to rail don't get a foothold.

But a new EPA study shows just how easy it would be for the United States to slash its dependence on oil, if we simply invested in these alternatives.

We currently import about 10 million barrels of oil a day. The government projects that, under our present "business as usual" policies, we'll still be importing about 10 million barrels a day in 2030. But if we used currently available technology, the EPA estimates that we could instead cut our demand for oil by 6.7 million barrels a day -- and that estimate does not include any possible savings from the use of natural gas vehicles in the truck and fleet sectors.

If we did so, world demand for oil would slump enough to drive prices down. (Inelasticity works both ways. When the price of oil drops, demand does not go up very fast.) Tar sands oil would be seen for the folly it is. And the snow would come back to Vancouver. Winter would be safe again.