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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 a barrel of oil. The two countries most affected by the dramatically shifting terms of trade between grain and oil are the United States and Saudi Arabia.
The United States, 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 nine-fold shift is also driving the largest U.S. trade deficit in history, which in turn is raising external debt to a record level, weakening the U.S. 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 United States largely could pay its oil import bill with grain exports. But in 2003, grain exports covered only 11 percent of the staggering U.S. oil import bill of $99 billion. While the exchange rate between grain and oil was deteriorating, U.S. domestic oil output was falling and oil consumption was rising, which means that oil imports were climbing. In 2003, oil imports accounted for 60 percent of total use.
The shift in terms of trade between the price of wheat, a surrogate for grain prices, and that of oil, is both 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 the 23-year span, a bushel of wheat could be traded for a barrel of oil in the world market. (See table and additional data.)
The first big adjustment between oil and wheat came when OPEC tripled the oil price at the end of 1973. During the 1974-78 period, it took roughly three bushels of wheat to buy a barrel of oil. Then in the years after the second OPEC oil price hike, which boosted the price of oil from $13 per barrel in 1978 to $30 per barrel 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 with dollars even as those of many oil-importing countries were being emptied.
In response to higher prices, world oil production outside OPEC expanded, thus loosening OPEC's grip on prices. Between 1985 and 1986 the price of oil dropped by half. From then until 1999, it took on average five bushels of wheat to buy a barrel of oil. During 2000-2003, it took seven bushels of wheat to buy a barrel of oil. Now in early 2004 it takes nine bushels.
What will happen to the wheat-oil exchange rate in the years ahead, no one knows for sure. In contrast to grain production, which can continue indefinitely, oil production is going to peak and decline at some point, probably within the next 5 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, then the peak will come later. But if they are preoccupied with boosting near-term sales, oil production may rise more rapidly, hastening the day when output will peak and start to fall.
Even as we anticipate the peaking of petroleum production, oil use continues to rise, especially in countries like China and India that are industrializing at a breakneck pace. China has already eclipsed Japan as an oil consumer, moving into second place behind the United States.
The United States is pressing the Saudis to produce more oil, but the answer is not for the Saudis to produce more, but for the United States to consume less. Even though the OPEC-engineered oil price hikes have signaled a need to use less oil, the United States has been rapidly 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 growing insurgency in Iraq could spread to other oil-exporting countries, 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 the United States can take to reduce oil use with existing technologies. For example, the 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 United States were to raise the fuel efficiency of its automobile fleet over the next 10 years to that of the Toyota Prius, U.S. 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 to substitute advanced technology for fuel.
The obvious next step is to modestly expand the electrical storage capacity of the gas-electric hybrids so that owners can plug in their hybrids to recharge the batteries during the nighttime hours when electricity demand drops. Short commutes could be powered entirely by electricity saving the gasoline for the occasional longer trips. This would enable the United States to substitute cheap wind-generated electricity for gasoline, further reducing gasoline use.
Shifting to more electricity in the hybrid engine fuel mix opens profitable new investment opportunities in developing the vast U.S. wind resources. According to the U.S. Department of Energy, the United States has enough harnessable wind power to satisfy total U.S. electricity needs several times over. And U.S. wind-generating capacity is growing fast. Between 1995 and 2003, it increased from 1,600 megawatts to 6,400 megawatts, quadrupling in five years.
The advances in wind turbine design that offer cheap electricity from wind help explain why some 22 states now have commercial scale wind farms pumping electricity into the local grid. With a renewal of the wind production tax credit, which is designed to establish parity with the subsidies for fossil fuels, growth could be even faster in the years ahead, creating thousands of new jobs.
We have spilled more than enough blood and spent more than enough of our treasure to protect access to oil supplies in the Middle East. RAND Corporation analysts calculate that even in peacetime it costs at least $30 billion per year to maintain the U.S. military presence needed to assure access to the region's oil. It is time for a change.
Unless the United States assumes a leadership role, Saudi Arabia will continue to dictate the terms of trade between oil and grain. This means they also will dictate U.S. gasoline prices. The United States, as the world's largest oil consumer and importer, can regain some influence on oil pricing by sharply reducing its dependence on oil. This would also delay the day when oil production peaks, buying the world time for a smoother transition to the post-petroleum era. The United States has the technologies and energy resources to lead this effort. What the world needs today is not more oil, but more leadership.
Copyright © 2004 Earth Policy Institute