Chevron's CEO: The price of oil

(Fortune Magazine) -- Oil companies are blamed (unjustly) for high gas prices, loathed for profiting from them, and criticized for their environmental record. So it's no wonder that most industry CEOs have made themselves scarce. Chevron's David O'Reilly is the exception. He regularly talks to reporters and appears on television to answer questions about Chevron and the industry.

O'Reilly, 60, joined Chevron 39 years ago after graduating from college in his native Dublin; he has been CEO for almost eight years, making him Big Oil's longest-serving chief. His record is strong. Chevron's market cap has increased by $100 billion on his watch, and its proven reserves have almost doubled.

O'Reilly sat down with Fortune's Geoff Colvin to talk about high oil prices, the future of alternative energy, the role of China and India, the presidential election, and much else. Here are edited excerpts.

Five years ago, oil was $25 a barrel. Recently it peaked at $96.70. What's the explanation?

Demand for oil has caught up with supply. It's very hard to justify any specific price, but we believe that prices will stay high because of growth in the developing world. In India you've seen almost 9% annual growth for five years. You've seen the impact of the population, the number of people who are driving cars, the amount of energy they're using to drive their industries, the improvement in quality of life. We're seeing that around the developing world, and that's what's driving oil prices.

Prices have been near record levels, yet Chevron just reported much lower quarterly profits - $3.7 billion compared with $5 billion last year. How can that be?

Let me do the math for a minute. At $90 a barrel, the cost of crude in a gallon of gasoline is about $2.25. In most states the federal and state taxes are 60 or 70 cents a gallon, so now you're up to at least $2.80 a gallon. Because the U.S. happened to be very well supplied with gasoline, that was the price it was selling for nationwide in most of the third quarter. Add the cost of transportation, refining, distributing, marketing - you're not going to make any money at that price. That's why our U.S. refining and marketing business did not make money in the last quarter.

With prices so high, buyers will find ways to use less oil, and governments will find new ways to reduce emissions related to global warming. Will oil become less important in the future?

The scale of the energy system is enormous. Forty thousand gallons of oil are consumed every second, and that represents only one-third of the total global energy system. To significantly change the energy mix is a big challenge, and I don't think it's likely to occur anytime soon. Very long term, a century out, maybe 50 years out, with new technology and changes in the capital structure - maybe some changes will occur. But in the next 25 years, it's unlikely there will be significant change.

The question, then, is how to reduce carbon emissions - a carbon tax, a cap-and-trade system, or something else?

Just to give you an example of how challenging this is, if you took every vehicle off the roads of the world today - all the trucks, all the cars, all the airplanes, all the trains - you would reduce carbon emissions by 14%.

If you took all the power generation off the face of the earth, all the commercial activity, all the residential heating and cooling off the face of the earth and went back to an agrarian society, you still wouldn't cut it by more than 60% or 70%.

We believe that the U.S. needs a carbon-management system. We're getting it by states today, and that's not very constructive. This is a nationwide and global problem, not a state problem.

As long as the rules are in place and predictable and understandable, we can compete. In a carbon-management environment, we believe people will focus on energy efficiency - the cheapest form of new energy we have. We're not doing enough to improve our energy efficiency in this country.

Any economist will tell you that the best way to get people to be more efficient is to raise the price.

The market is already telling us that we need to be more energy efficient. We're talking about $96 or $98 oil. What more incentive do we need?

But people seem to keep buying gasoline regardless of price.

I don't agree with that. We are seeing some evidence now of reduced demand as gasoline prices have risen. Gasoline is what gives us mobility, so people have to use it.

So are superhigh oil prices good or bad for Chevron?

I don't think they're particularly good for anybody, including Chevron, because it disrupts the economy. My great fear is that there could be an economic recession if the price gets too high too fast. I don't think that's healthy.

In a speech earlier this year you said, "Reduction of greenhouse-gas emissions must involve all the major emitting nations in the world." Well, China just became the No. 1 emitting nation. What if it refuses to cooperate?

I think it's in their interest to cooperate, because managing carbon emissions will drive efficient use of energy, and they're the second-largest energy importer after the U.S. China can reasonably argue, as can India and other developing countries, that they may not need to be as aggressive because they are further behind in development and because they have hundreds of millions of people trying to move up the socioeconomic ladder. But I do believe it's in the best interests of the major consuming countries to manage carbon and drive energy efficiency.

Chevron is investing in some alternative-energy projects - geothermal, biodiesel, hydrogen. Are you making money?

We make money in geothermal. We're the largest geothermal producer in the world. We're continuing to expand and invest in that business. That has now moved along the maturity curve to where it is a good moneymaking business.

In the other areas we're not making money. We're investing - particularly in "second generation" ethanol, which is ethanol from nonfood sources. There's a limit to how much corn-based ethanol this country can produce. We're already seeing stresses in the system - corn prices going up, land prices going up, food prices going up.

So can we find nonfood crops or waste that we can convert into ethanol and augment the fuel supply in a sensible way? It's proving difficult. It isn't commercial yet, but it's one area of focus.

As for hydrogen, we've demonstrated the efficiency of producing it at service stations. You take natural gas, convert it into hydrogen, and pump it into the car. The problem is that we're using natural gas, so you're back to hydrocarbons again, and that doesn't seem as good a long-term solution as, say, ethanol from nonfood crops.

These alternative-energy investments are not very large relative to the size of the company. A skeptic could say that they're really just good public relations expenditures. Is that wrong?

That's absolutely wrong. Over three years we've invested $2.5 billion. We're not going to spend $2.5 billion just to make people feel good. We're spending that money because we believe it's going to create shareholder value. But you're right - relative to the size of the rest of our system, it's still a modest investment. We're investing $20 billion a year in new energy supplies, and most of that energy is oil and gas.

China has been buying oil assets around the world, especially in Africa. Does that represent a danger for the world, and is it a competitive danger for Western oil companies?

The system is so big that I believe there's room for a lot of competition, and competition ought to be encouraged.

My concern is that policymakers in the U.S. seek to hogtie us. They are increasing taxes and limiting what we can do, when they ought to be encouraging us to invest. For example, 85% of our coastlines are off-limits to exploration. Britain allows exploration around its coast, Denmark allows coastal exploration, Norway, Australia - what's wrong with our country?

Why not open our coast up? It can be done in an environmentally sound way. The government puts it off-limits and at the same time calls for energy independence. What sense does that make?

Is energy independence possible for the U.S.?

Not in the foreseeable future - not for decades.

The presidential election is less than a year away. Based on energy policy, whom do you like?

None of them particularly. I don't think anyone has really got a plan, whether in the current administration, in the current Congress, or among the candidates. They're all taking a simple, relatively short-term view. You've got to take a view that you're going to look at this over 25 years or longer.