The Saudis have America over a barrel

IN 1970, A BUSHEL OF WHEAT could be traded for a barrel of oil in the world market. It now takes nine bushels of wheat to buy one barrel of oil. The two countries most affected by this are the U.S. and Saudi Arabia. America, the world's largest importer of oil and its largest exporter of grain, is paying for this shift in the wheat-oil exchange rate with higher gasoline prices. The ninefold rise also is driving the largest U.S. trade deficit in history, which in turn is raising external debt to record levels, weakening the American economy. In contrast, Saudi Arabia, the world's leading oil exporter and a high-ranking grain importer, is benefiting handsomely.

During the early 1970s, before the oil price hikes by OPEC, the U.S. largely could pay its oil import bill with grain exports. In 2003, however, grain exports covered a mere 11% of the staggering U.S. oil import bill of $99,000,000,000. While the exchange rate between grain and oil was deteriorating, U.S. domestic oil output was falling and consumption was rising, meaning that oil imports were climbing. In 2003, oil imports accounted for 60% of total use.

The shift in terms of wade between the price of wheat, a surrogate for brain prices, and that of oil, is dramatic and ongoing. From 1950 to 1973, the prices of wheat and of oil were remarkably stable, as was the relationship between the two. At anytime during that 23-year span, a bushel of wheat could be traded for a barrel of oil in the world market.

The first big adjustment came when OPEC tripled the price of oil near the end of 1973. From 1974-78, it took roughly three bushels of wheat to buy a barrel of oil. Then, in the years after the second OPEC price hike, which boosted the price of oil from $13 per barrel in 1978 to $30 in 1979, it took seven bushels of wheat to buy a barrel of oil.

This steep rise in the buying power of oil led to one of the most abrupt transfers of wealth in history. The coffers of major oil exporters, such as Saudi Arabia, Kuwait, and Iran, began to overflow at the same time those of many oil-importing countries were being emptied. In response to higher prices, world oil production outside OPEC expanded, thus loosening OPEC's monopolistic grip. Between 1985-86, prices dropped by half. From then until 1999, it took on average of five bushels of wheat to buy a barrel of oil. During 2000-2003, it took seven bushels. Now it takes nine.

No one can say for certain what will happen to the wheat-oil exchange rate in the years ahead. In contrast to grain production, which can continue indefinitely, oil production is going to peak and decline at some point, probably within the next five to 15 years. Exactly when it peaks depends on the depletion strategies adopted by the major oil companies and oil exporting countries. If they decide to stretch their dwindling reserves by lowering production to extend the lifetime earning period of their oil fields, the peak will come later. However, if they are preoccupied with boosting near-term sales, production may rise more rapidly, hastening the day when output will crest and start to fall.

Even as we anticipate the maxing out of petroleum production, oil use continues to grow, especially in countries like China and India that are industrializing at a breakneck pace. China already has eclipsed Japan as an oil consumer, moving into second place behind the U.S. America is pressing the Saudis to produce more oil, but the answer is not for the Saudis to produce more, but for America to consume less. Even though the OPEC-engineered oil price hikes have signaled a need to use less oil, this country rapidly has been expanding its fleet of gas guzzling SUVs, boosting oil use and imports.

Even as U.S. dependence on Middle Eastern oil is rising, so too is political instability in the region. The burgeoning insurgency in Iraq could spread to other oil-exporting nations, disrupting oil supplies. If ever there was a time to get serious about boosting auto fuel efficiency, it is now. There are many steps that can be taken to reduce oil use with existing technologies. For example, new cars with hybrid gas-electric engines, such as the Toyota Prius and the Honda Civic, are remarkably fuel-efficient. The 2004 Prius averages 55 miles per gallon (mpg) in combined city and highway driving, double or even triple that of other midsize cars.

If the U.S. were to raise the fuel efficiency of its automobile fleet over the next 10 years to that of the Toyota Prius, gasoline consumption could be cut in half. This would not require any reduction in the number of cars, only the use of more efficient engines. The gas-electric hybrid cars may represent the most sophisticated automotive engineering on the road today. In effect, what the engineers who designed the hybrids have done is substitute advanced technology for fuel.

The obvious next step is to expand the electrical storage capacity so that owners can plug in their hybrids to recharge the batteries during nighttime hours when electricity demand drops. Short commutes could be powered entirely by electricity, saving gasoline for the occasional longer trips. This would enable the U.S. to substitute cheap wind-generated electricity for gasoline, further reducing waste.