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Crude Awakening

The U.S. Finally faces the cost of its addiction to foreign oil

By Patricia Smith

Click here for graph.
Tim Chou used to drive a 1996 Nissan Quest. But this summer, as the price of gas skyrocketed past $4 a gallon, the 19-year-old engineering student at the University of Illinois was forced to give up his S.U.V. "My parents decided to donate my car to charity because they didn't want to pay for the insurance and gas anymore," Chou says.

The soaring price of oil—nearing $150 a barrel—is inflicting pain at the pump and beyond as Americans begin to see the real cost of their gas-guzzling cars, suburban sprawl, and big houses that use lots of energy to heat and cool.

Some habits are already starting to change. Officials report more use of H.O.V. lanes for carpoolers and increased ridership on mass transit. Even the summertime ritual of teenagers cruising has been affected. "I used to drive around and hang out here with my friends five nights a week last summer, but I just can't afford to buy gas anymore," says Elliot Lee, 19, of East Dundee, Ill.

And people are rethinking the benefits of far-flung suburbs: "Living closer in, in a smaller space, where you don't have that commute—it's definitely something we talk about," says Phil Boyle of Elizabeth, Colo., who drives an hour to his job in Denver. "Before it was, 'We spend too much time driving.' Now, it's, 'We spend too much time and money driving.' "

Burgers & iPods

While the prices at the pump are what people, and the media, are focusing on, the reality is that oil prices have a much broader impact. The cost of energy is built into the price of everything we buy. When Abercrombie or McDonald's pays more to get their jeans or burgers into stores, at some point they're likely pass the additional cost on to you. And because plastic is made out of petroleum products, it costs Coke and Apple a lot more to make their soda bottles and iPods.

All this is leaving consumers with less money to spend on everything else—from houses to restaurants and vacations—which is hurting an already sluggish U.S. economy, and sending the stock market into a steep fall.

Why The Spike?

Particularly hard-hit is the U.S. auto industry. In recent years, Detroit has focused on producing gas-guzzling S.U.V.'s, which were hot sellers until it started to cost $100 to fill their tanks. At the same time, foreign carmakers, who have years of experience selling smaller, fuel-efficient cars, are now better positioned to sell their vehicles. And with fuel one of their biggest costs, airlines are also taking a beating.

A decade ago, oil cost less than $11 a barrel. For most of the 20th century, as it transformed the world, oil was abundant and easy to find. But in the last year and a half, the price has more than doubled. It neared $150 a barrel this summer, prompting Congress to hold hearings on whether speculators are driving up prices.

Why the sudden spike? In the past, dramatic increases in the price of oil were usually caused by sudden disruptions in supply (like a cutoff in shipments from the Middle East). This time, however, prices are soaring largely due to an increase in demand for oil, primarily from the booming economies of China, India, and other developing nations.

And that increasing demand is unlikely to slow. In fact, demand for oil from China and India alone is expected to double in the next 20 years as their economies continue to grow—and their exploding middle classes are able to buy millions more cars and air conditioners. At the same time, the appetite for bigger cars and houses has kept American demand for oil, most of which is imported, climbing: 21 million barrels a day last year, up from 17 million in the early 1990s.

Also putting upward pressure on oil prices are tensions in the Middle East and other oil-producing regions. Of particular concern are Iran's nuclear program, the war in Iraq, violence in Nigeria, and Venezuelan President Hugo Chavez's general unpredictability.

Ironically, the $4 gasoline that Americans find so hard to stomach looks downright cheap in many countries. Most countries have long imposed steep taxes on gas to encourage conservation. By comparison, U.S. gas taxes barely factor into the price at the pump. Americans pay, on average, 49 cents in tax per gallon. Canadians pay more than double that, $1.26 per gallon, and the most-taxed of all, the Dutch, pay $5.57 in tax, for a total price of $10.05 per gallon.

Many economists say taxing gas in a meaningful way would be the most effective way to cut our dependence on foreign oil, encourage the development of alternative energy sources, and address the issue of climate change. The problem is, American politicians, including those running for President, don't like to talk about raising taxes.

Republican John McCain favors lifting the ban on off-shore drilling (though not the ban on drilling in the Arctic National Wildlife Refuge) and proposed a summer suspension of the federal gas tax to give consumers some immediate relief. Democrat Barack Obama opposes both those measures, focusing instead on conservation and alternative energy.

A July report by the International Energy Agency predicted that world demand for oil would continue to climb. And increased supplies aren't likely to come to the rescue either.

"After five years of record increases in oil prices, producers are still unable to sufficiently expand output," says energy analyst Chris Ruppel. "It means we are in for rough times."