Floor on the price of oil

Tom Friedman had a recent op-ed piece entitled "Only Halfway There" (Times Select subscription required). He argues that pressuring President Bush to withdraw from Iraq is only half the game; the equally important other half is to reduce our dependence on oil:

...and there is only one way to do that: get the price of oil right. Either tax gasoline by another 50 cents to $1 a gallon at the pump, or set a $50 floor price per barrel of oil sold in America.

Introducing a direct gas tax is politically very challenging. A $50 floor on the price of oil is much more intriguing. Since the price of oil is currently well above this value, it may be more palatable to levy this tax---the tax doesn't actually kick in until the price of oil falls below $50. The likely payoff from such a tax is:

Once energy entrepreneurs know they will never again be undercut by cheap oil, you’ll see an explosion of innovation in alternatives.

Talk of a $50 floor price reminds me of a great talk by Vinod Khosla. Khosla has become a very strong proponent of the use of ethanol in cars. He makes a very persuasive case for why this isn't just possible, but is actually quite probable. First, Brazil has already made such a transition: all cars run on any mix of gas and ethanol, and fuel pumps dispense both gas and ethanol; drivers can make the choice based on price. Second, a variety of different interests seem to agree on ethanol:

• The agriculture lobby (like ADM), loves ethanol---it gives their crops a huge market (in the US corn is currently used to make ethanol; more on this below).
• The defense establishment believes that ethanol can provide energy security by weaning the US away from its dependence on Middle East oil.
• Environmentalists (apparently) prefer burning ethanol to gasoline.
• Domestic car companies may prefer cars that burn both ethanol and gasoline ("flex fuel"). On the one hand it costs very little to retrofit today's cars to burn ethanol or gas (I remember him saying its about $25 per car). On the other hand, companies like GM are feeling that they've lost the hybrid battle to Toyota. They want their own "green" marketing message, and ethanol may provide just what they need. (I wonder if this argument has weakened in the year since I heard Khosla, since now I hear more about hybrids and less about flex fuel.)

The bottom line is that ethanol may be supported by most parties, except big oil. Which brings us back to the floor on the price of oil. Khosla said that he had given this talk at Davos. After the talk, a senior executive at a major oil company came up and essentially threatened him saying that his vision of an ethanol society would fail because, if necessary, the oil companies would drop the price of oil down to, say, $20 per gallon. This would make all alternative energy sources economically non-viable, thus driving all such companies out of business. Khosla, of course, took this as a challenge and vowed to lobby for a floor on the price of oil, thus protecting the interests of these alternate energy companies!

One important note: generating ethanol from corn (the dominant strategy in the US) is not the best strategy for a variety of reasons (including cost and the amount of energy required for generation). Brazil generates ethanol from sugarcane, a much better method. But import tariffs prevent Brazilian ethanol from competing with US ethanol. Khosla was suggesting an alternate source: native plants like switch grass can be converted into ethanol. The technology isn't quite there to do this, but Khosla has great faith in the power of technology to overcome such hurdles.

Which brings me to the last point: Khosla Ventures is investing in a big way in ethanol, so he clearly has some conflict of interest. Nonetheless, he painted a compelling vision of the role of ethanol. It'll be interesting to see how the ethanol story plays out and how it compares to other sources of energy such as solar and nuclear.