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Obama's Alternative Energy Fiasco

sam.staley@reason.org (Samuel Staley) — Sun, 17 May 2009 13:22:00 EDT

Those skeptical of the Obama Administration's green energy initiatives will find Jon Utley's column at Reason.com worth a read. It's one thing to bolster R&D for untested and uncertain technologies such as wind and solar. It's quite another to activity shift us away from energy sources such as oil and gas that are delivering high energy output cheaply before the new technologies are viable. But, that's what we are doing.

Notes the ever engaging Utley,

"Americans will soon again feel the sting of gasoline costing $3.00 or $4.00 per gallon and then come to recognize how we've wasted years of opportunity to produce more energy domestically. For instance, the U.S. Geological Survey estimates that there are 85 billion barrels of offshore oil. (And that is an old number. It is almost certain to increase once new exploration and testing are permitted.) New supplies in continental America, not to mention the billions of barrels now accessible in Alaska, could transform our trade deficit by cutting hundreds of billions of dollars in imports. This would help rescue the value of the dollar, alleviate the cost of maintaining armies and navies in the Middle East, and help save free trade from the latest round of restrictions.

It's also essential to remember that so-called renewable energy cannot replace oil and natural gas in any significant way. For example, corn-based ethanol production "costs" nearly as much to produce as it saves in oil and can only exist with the help of costly and unending subsidies. Government, in other words, gets what it pays for. If it offers subsidies to alleviate global warming or make gasoline from grass, it will find promoters who will gladly accept that money and deliver scant results."

Has U.S. Demand for Oil Peaked?

sam.staley@reason.org (Samuel Staley) — Mon, 13 Apr 2009 10:29:00 EDT

An excellent article in the Wall Street Journal today examines trends in the U.S. demand for oil. Many analysts, including those at Exxon Mobile, believe demand has peaked. Even if prices remain low, and the economy rebounds, few believe demand will reach pre-2007 levels.

Among those who say U.S. consumption of gasoline has peaked are executives at the world's biggest publicly traded oil company, Exxon Mobil Corp., as well as many private analysts and government energy forecasters.

The reasons include changes in the way Americans live and the transportation they choose, along with a growing emphasis on alternative fuels. The result could be profound transformations not only for the companies that refine gasoline from crude oil but also for state and federal budgets and for consumers. Much of contemporary America, from the design of its cities to its tax code and its foreign policy, is predicated on a growing thirst for gasoline.

We are commuting less (despite so-called sprawl), driving smaller cars, and using more public transit. So, demand for oil has moderated.

Demand for all petroleum-based transportation fuels -- gasoline, diesel and jet fuel -- fell 7.1% last year, according to the EIA. This is the steepest one-year decline since at least 1950, as far back as the federal government has reliable data.

Many industry observers have become convinced the drop in consumption won't reverse even when economic growth resumes. In December, the EIA said gasoline consumption by U.S. drivers had peaked, in part because of growing consumer interest in fuel efficiency.

Exxon believes U.S. fuel demand to keep cars, SUVs and pickups moving will shrink 22% between now and 2030. "We are probably at or very near a peak in terms of light-duty gasoline demand," says Scott Nauman, Exxon's head of energy forecasting.

Of course, many people probably don't believe today's currently low prices will stay there. Once the economy takes off here and abroad, demand for oil (and gasoline) in China, Brazil, Eastern Europe, and elswhere will take off again. We may well be looking at $4 per gallon gas again.

Falling demand for oil, however, should not be confused with falling demand for mobility. Wealthy people want to travel more, as Adrian Moore and I discuss in chapter 3 of our book Mobility First. I also discuss this in the context of public transit here.

We will want more mobility, but will opt for non-oil based ways to propel us.

ANWR Morass Redux

adrian.moore@reason.org (Adrian Moore) — Wed, 18 Mar 2009 14:05:00 EDT

The latest round of statements about drilling for oil under the Alaska National Wildlife Refuge (ANWR) are finally getting a bit more rational.

Interior Secretary Ken Salazar said Monday he would consider tapping oil from Alaska's Arctic National Wildlife Refuge by drilling outside its boundaries if it can be shown that the refuge's wildlife and environment will remain undisturbed.

But Salazar emphasized that the Obama administration stands firm that the Alaska refuge, known as ANWR, "is a very special place" that must be protected and that he is not yet convinced directional drilling would meet that test.

Sen. Lisa Murkowski, R-Alaska, has introduced legislation that would allow companies access to oil beneath the Arctic refuge's coastal plain through directional drilling from outside the refuge itself. Murkowski contends such drilling would leave the refuge surface land undisturbed, protecting wildlife.

OK, so Salazar is opening the door--you can drill the oil if doing so will leave the wildlife and environment "undistrubed." I think unharmed is a more rational standard than undisturbed. And Murkowski is also obviously opening the door a bit, but clings to the bit more unreasonable "leave the refuge surface land undisturbed, protecting wildlife."

You don't have to leave the land undisturbed to protect wildlife. Habitat can be both more delicate and more resilient than people think. What actions in a given area will actually harm habitat and wildlife is an empirical question. The door Salazar and Murkowski are opening hear needs to be a bit wider, to allow a rational look at if there are ways to extract the oil under ANWR without doing harm to the habitat there, a rational look based on objective measures and science.

Such approaches are commonplace on lands held by private conservation groups. In Reason's Policy Brief Digging Our Way Out of the ANWR Morass, Michael DeAlessi laid out how it might work in ANWR

If drilling in the ANWR must meet a set of environmental performance measures, then industry can use them as a basis to plan its operations, and environmental groups will have not only the assurance that a certain level of environmental protection will be met, but the leverage to hold industry and government to those standards.

. . .

It is time for the ANWR debate to move forward and leave the bickering behind. Uncertainties over just how many barrels of oil will be recovered or what new technologies may allow will never be resolved. We do, however, have the management/performance tools and the guiding principles of ENLIBRA to work with to ensure that whatever development does take place is done so in an environmentally responsible manner.

Some Possible Performance Measures for ANWR (and other public lands)

Many performance measures are site specific, and the following list is very much a work in progress.
■ Increases or decreases in specific species population numbers over time; likely species include porcupine caribou, musk ox, grizzly bears, wolves, and many species of birds;
■ Well-defined recovery targets for these species, such as minimum population size over a specific area;
■ Increases or decreases in other species that may be common or unthreatened, but which are often good indicators of overall ecological health;
■ Increases or decreases in acreage of specific wildlife habitat types;
■ Increases or decreases in invasive species over a specific area;
■ Specific measures of water quality such as parts per million of nutrients such as phosphorus and nitrogen;
■ Specific measures of pollution releases; and
■ Percentages of targeted habitat that meets specific criteria for ecological health.

The Oil Price Bubble Bursts

Tue, 18 Nov 2008 00:00:00 EST

Oil prices have dropped by 60 percent since July. And they fell without the benefit of a gasoline tax holiday, new anti-speculator regulations, or a windfall profits tax on oil companies. A year ago, crude oil was going for $88.00 per barrel and gasoline cost an average of $2.76 per gallon. Over the following months, the price soared, reaching an inflation-adjusted record high of just over $147 per barrel in July. Then the bottom fell out. Yesterday, the price was hovering around $58, up from a recent low of $53 per barrel. The result is gasoline prices plummeting from a national average of $4.11 per gallon in July to below $2.07 per gallon now. So what happened?

First, just as one would expect, higher prices led to lower demand. U.S. demand for petroleum in 2008 was 5.4 percent lower than in 2007, falling by 1.1 million barrels per day (bpd) from 20.7 million to 19.6 million barrels per day. As prices rose Americans curtailed their driving. The Federal Highway Administration reported that in August 2008, Americans drove 15 billion fewer miles, or 5.6 percent less, than they did in August 2007. On the other hand, recent high prices have called forth new sources of supply. For example, Canadian oil sands now produce 1.1 million barrels per day. And new deepwater offshore production rigs like the Thunder Horse (250,000 barrels per day) and Tahiti (125,000 barrels per day) platforms are coming online. Falling demand and increasing supply mean lower prices.

In addition, a good portion of the lower demand for oil is the result of the global economic slowdown. "This time the usual petroleum boom/bust cycle lined up on top of the business cycle," said Tim Evans, an energy futures analyst at Citigroup's Futures Perspective. In March 2008, Evans warned that we were in the midst of a bubble and that oil prices would drop. When the investment firm Goldman Sachs suggested the possibility of $200 per barrel oil, Evans predicted that prices would fall to $60 to $70 per barrel. He observed presciently that "this is the riskiest time to be long in crude oil since 1980."

So as prices drop will demand increase? Yes, but Evans believes that U.S. demand will rise slowly. Why? In part because various federal government policy responses to recent high oil prices are unlikely to be reversed. For example, the Federal government has mandated that Corporate Average Fuel Economy standards for automobiles rise from 27.5 miles per gallon now to 35 miles per gallon by 2020. Evans thinks that hybrid automobile technology may look economically attractive even at current prices. Plug-in hybrids like the Chevy Volt should use about 2 cents of electricity per mile compared to 12 cents per mile of gasoline. In addition, Evans says, "The biofuels initiatives aren't going to go away. Even if they are not economically smart, the votes are there to make sure that we stick with these programs." So subsidized biofuels will displace some demand for gasoline, putting downward pressure on the price of crude oil.

On the supply side, those "windfall profits" that oil companies have been earning in the last couple of years are paying for exploration and development of more oil supplies. It is true that the oil companies have been using their record profits to buy back stock and thus increase shareholder value. Some members of Congress believe that the oil companies should spend their profits on alternative energy projects that the companies don't believe can be justified economically. And if the oil companies don't stop enriching their shareholders, Congress will see to it that the "windfall profits" are taxed away and spent by government bureaucrats on alternative energy projects. It is possible that the members of Congress know better how to spend oil company profits than do their executives, but the Federal government's record in this area is not impressive.

Naturally, suppliers don't like lower prices, so the members in the Organization of Petroleum Exporting Countries (OPEC) want to drive up prices by restricting supply. In October, OPEC members pledged to cut oil production by 1.5 million barrels per day beginning on November 1. They plan to hold another meeting later this month to discuss further reductions. Even as consumers enjoy lower prices at the gas pump now, analysts at the International Energy Agency fret that they will lead to underinvestment in oil production capacity, resulting in a crude oil supply crunch by the middle of the next decade. Disturbingly, 80 percent of the world's known oil reserves are owned by government oil companies whose revenues are looted rather than reinvested in production. In any case, lower prices and the credit crunch are already causing oil companies to shelve some projects. Alternative energy promoters also fear lower petroleum prices because they make their projects even less economically feasible. Some are advocating a higher gasoline tax in order to counteract the deleterious effects of lower crude oil prices on the glorious alternative energy future.

So what's next for oil prices? For the coming year, Evans thinks that the price of oil will bounce around in a trading range of $50 to $90 per barrel, averaging around $70 per barrel.

Ronald Bailey is Reason magazine's science correspondent. His book Liberation Biology: The Scientific and Moral Case for the Biotech Revolution is available from Prometheus Books.

Disclosure: Yes, I still own those 50 shares of XOM that I bought with my own money. The shares are down 12 percent from their high this year.

Gas Tax Increase or Private Capital?

sam.staley@reason.org (Samuel Staley) — Wed, 16 Jul 2008 00:00:00 EDT

Congress isn't waiting to see who wins in November before deciding how to spend the next trillion dollars or so on the nation's roads, rails, bridges, and tunnels. Yet, all the beltway jockeying for transportation money may be diverting attention from an even bigger problem: our inability to tap into billions of private capital as our competitors soak up a growing worldwide pot of infrastructure funds.

The stakes are high. We're not just faced with the problem of how to maintain and repair our roads and rails. We also need to find a way to come up with billions of dollars to redesign and reconfigure our transportation network for the 21st century. That's a big challenge because we are already facing an annual transportation deficit of at least $75 billion, according to groups such as the American Society of Civil Engineers and the National Cooperative Highway Research Program, the National Surface Transportation Policy and Revenue Commission.

But where will the money come from?

Some are holding out for a major increase in the gas tax to fund infrastructure needs. The National Surface Transportation Policy and Revenue Commission recommended a hike of 60 cents. Many in Congress would like to see a gas tax increase increase, but most insiders doubt they can get much more than a few pennies at the end of the day. Few see Congress rushing in to hike the gas tax in the midst of record-high gas prices and a slumping economy.

Further complicating a gas tax option is its scale: even if taxes were increased dramatically the gas tax still wouldn't provide all of the needed funding for road projects.

Meanwhile, the US is in danger of leaving billions of infrastructure dollars on the table for other countries to eagerly snatch up. Private investments funds are capable of leveraging $525 billion for infrastructure investments worldwide, more than 10 times the amount available just eight years ago. These funds are simply looking for the right places to invest. And thus far they've found them outside of the United States.

Europe and Asia have decades-long histories of tapping into private equity to fund their transportation infrastructure using public-private partnerships. France has virtually its entire limited access highway system under the management of privately-owned firms, including Cofiroute, ASF, APRR, and Sanef. Australia has been tapping into private capital using companies such as Macquarie and Transurban to build tunnels and tollroads in its major cities since the 1990s. Italy and the United Kingdom claimed nearly half of the private investment in public infrastructure between 2003 and 2006 among the 20 nations that make up the Organization for Economic Cooperation and Development (OECD), according to Standard & Poor's.

China may be the most aggressive in using private capital to build its transportation infrastructure. The nation is embarking on an epic road-building program that will match the size of the US Interstate Highway System and be completed in less than half the time. Its expressway network is intended to link all provincial capitals, 80 percent of the nation's population, and 90 percent of the nation's ports, according to a report prepared by the China Construction Bank Corporation (CCBC). Most of these expressways are being financed by tolls, and the tollway companies depend on private capital to finance them.

The US lags behind all of these countries. Just a handful of projects have closed in the US for a fraction of the amount of capital available on the global market, most notably the $3.8 billion Indiana Toll Road and the $1.8 billion Chicago Skyway. In a positive sign, three Greenfield (new) toll road deals were signed recently in California, Texas and Virginia. The combined investment value, however, doesn't even match the Indiana deal. While a consortium of domestic and foreign companies submitted bids to lease the Pennsylvania Turnpike, the winning bid of $12.8 billion is still far from a done deal even though it is strongly supported by Democratic Governor Ed Rendell.

The US market appears to be limited largely for political reasons. In the immediate aftermath of the Indiana and Chicago partnership deals, Congressmen James Oberstar (D-MN) and Peter DeFazio (D-OR) sent a letter to governors and state highway officials warning them that the US House Committee on Transportation and Infrastructure would "work to undo any state public-private partnership (PPP) agreements that do not fully protect the public interest and the integrity of the national system."

A strong response from state officials quelled some the protest from Capitol Hill and the short-term momentum to rein in public-private partnership projects. Nevertheless, proponents of public-private partnerships were put on notice that the federal government might become active in discouraging the further use of private capital in highway and transportation projects.

We may be giving private capital, even US-based funds, little choice but to invest their billions in fruitful, but less lucrative projects abroad. That would be unfortunate for the US, undermining our global competitiveness and undercutting efforts to shore up a transportation system desperately in need of an extreme makeover. Unless national transportation policy gets on track and embraces private capital, our transportation system will continue to lag far behind our global competitors.

The Myth of the Gas Price "Crisis"

sam.staley@reason.org (Samuel Staley) — Thu, 19 Jun 2008 00:00:00 EDT

Once again, Americans are besieged by a crisis. You can't turn on the cable news channels without hearing about "sky-high" gas prices and our "addiction" to foreign oil.

Sen. John McCain wants to suspend the gas tax. Sen. Barack Obama wants a "windfall profits tax" on oil companies. And both major political parties seem to support funding various programs to find alternatives.

But are high gas prices really a "crisis"?

"For many Americans there is no more pressing concern than the price of gas,'' President Bush said at the White House on June 18th. "Congress must face a hard reality. Unless members are willing to accept gas prices at today's painful levels or even higher, our nation must produce more oil."

At its root, today's gas prices reflect a simple market reality: the world pumps 85 billion barrels of oil out of the ground each day while the world wants to consume 87 billion barrels. Moreover, developing nations, primarily India and China, but also Brazil and eastern European countries, are growing rapidly, pushing long-term demand even higher.

It also doesn't help that our capacity to pump and refine oil is stubbornly resistant to expansion. A new refinery hasn't been built in the US since the 1970s.

Some of this inelasticity is economic-oil companies and refiners remember all too well the industry wide recession triggered by falling gas prices in the 1980s and 1990s after an equally severe price spike in the 1970s. Most of the inelasticity, however, is political-unrest in Nigeria and Iraq, saber rattling in Venezuela and Iran, or special interest opposition in the US and Western Europe.

So, in reality, today's prices reflect the mismatch between supply and demand. The prices we face today, at the gas pump and on the world market, are really a normal and essential market outcome.

So what will we do? First, as in previous cases, we'll cut down how much we drive. In fact, vehicle miles traveled, a common measure of demand, has fallen over the last year in the US.

Second, once we think the high prices will stay around for a while, we will begin to change how we get around. Fortunately, most of us won't be forced to dramatically change our lifestyles. Simply dumping the SUV for a hybrid, four-door sedan essentially neutralizes the effect of the run up in gas prices over the last two years.

The more important step, however, will be long-term changes. That's when, with the help of the profit motive, new kinds of vehicles will be available on a broad basis for consumers throughout the economy. That's when we take advantage of an emergence of electric-only vehicles, perhaps even a version of the new Tesla sports car - currently over $100,000 for a car that goes about 220 miles per charge - will be priced low enough for the middle class. Honda has already launched the emissions-free, hydrogen fuel cell FCX Clarity for a limited run before going into mass production within 10 years. Drivers already have 20 different hybrid models to choose from. There should be 65 hybrid models by 2010.

While many working-class families will have to change their lifestyles or spending habits to deal with higher gas prices, most won't. The median household income in the US is now $48,000 per year. Higher gas prices would be equivalent to about a 1 percent reduction in their total income at today's prices. Most families will have the financial flexibility to make adjustments needed to accommodate higher prices.

As painful as it is for many, the correct response to high gas prices is to simply let the market work, not use them to justify billion dollar programs on inefficient fuel alternatives or adopt politically expedient gimmicks like a gas tax holiday. Market economies provide the natural incentives to both suppliers and consumers to ensure the needed adjustments will be made at the right time with the right technologies. We don't need politicians or energy planners to trump market decisions.

As Gas Prices Rise-We'll Adapt

sam.staley@reason.org (Samuel Staley) — Thu, 22 May 2008 00:00:00 EDT

Americans may shake their fists at $4 per gallon gas on Memorial Day, but these frustrated gestures will mean little in the long run if experience is any guide. We won't sell off the car and hoof it to work. We won't move to apartments and townhouses in the big city. Instead, we'll do what Americans do-innovate to make our lives even better off instead of accepting a lower standard of living.

Conventional wisdom, of course, says otherwise. Some environmental activists and other anti-car ideologues are practically beside themselves with joy as gas prices climb higher. Public transit use is up, and some early evidence suggests that home prices are falling faster in far-flung places with long commutes. Perhaps, they hope, Americans are finally breaking from their "addiction" to gas guzzling automobiles and making the "right" choices by living in smaller homes in dense neighborhoods in congested cities closer to their jobs.

Many politicians, including, presidential candidate Sen. Barack Obama are on the bandwagon. Obama recently criticized the "Big 3" automakers during a stop in Warren, Michigan for making cars people wanted to buy - trucks, minivans, and SUVs - rather than the money-losing smaller cars produced by their Asian competitors.

"Now, a big part of the reason autoworkers are struggling on the factory floor is because of decisions that were made in the boardroom. Rather than invest in the fuel-efficient cars of the future," the senator-turned-economic soothsayer said, "auto executives invested in the SUVs and large trucks that may have helped meet a rising demand, but that essentially guaranteed that they would be outpaced by foreign competitors and that the industry's long-term problems would be harder to solve."

Republican candidate Sen. John McCain has also called for increased fuel efficiency standards on cars sold in the U.S., but the real world shows the backseat driving by politicians and others is wrong. While gas prices are likely to increase over the long-term, technology and innovation are likely to keep the car and automobility at the top of our livability agenda.

First, take the experience of Europe. Gas prices now exceed $8 per gallon in Belgium, France, Germany, Italy, and the United Kingdom according to the U.S. Department of Energy. Yet automobile travel is booming. "Despite efforts to promote the popularity of other transport modes," the European Commission writes, "the car remains the personal means of transport par excellence." The number of passenger cars per capita has increased five times faster in Europe than in the U.S. since 1990.

Second, let's take a look at U.S. public transit. Undoubtedly, higher gas prices are pushing more people out of their cars and onto buses and trains. In some cases, transit ridership is up 10 or 15 percent over last year.

But, how significant is this jump? Only public transportation in New York and San Francisco can claim a metropolitan wide market share of more than 5 percent. Regional transit accounts for less than 4 percent of all travel in Boston, Chicago, and Washington, DC, despite hosting some of the most extensive systems in the nation. Transit's share of travel in growing cities such as Los Angeles, Phoenix, Houston, and Atlanta barely even registers on the travel radar screen.

A far more important indicator is how Americans will adapt to maintain their standard of living and quality of life.

Higher gas prices will not just spur more oil exploration. They will drive the search for new ways to provide the mobility American consumers want by reducing the need for oil. Twenty-two hybrid car models were already sold in the U.S. market when Toyota sold its one-millionth Prius in 2008. JD Power and Associates estimates that 65 hybrid models of cars, trucks, and SUVs will be available by 2010. As Obama pointed out in Michigan, "GM is releasing an average of one new hybrid model every three months for the next two years. So we're certainly taking steps in the right direction." As gas prices climb even higher, automobile companies will inevitably ratchet up their efforts to compete on energy efficiency just to survive.

Even if automobile technology lags consumer demand, we shouldn't underestimate the ability of Americans to find new ways to preserve their lifestyles. Already, telecommuters outnumber public transit riders in half of the top 50 American cities. Job growth in the suburbs has outstripped traditional cities for decades. High gas prices will likely accelerate these trends.

In the end, elected officials would be far better off letting international oil markets work on their own without interference from Congress or regulatory agencies. In a dynamic, market-based economy, consumers will make the adjustments necessary to maintain their standard of living and provide the proper incentives for car and energy companies to develop new products to meet these shifting desires. Intervention by misguided backseat drivers will do more to prevent these changes than encourage them.

Dingell Bells

info@reason.org (Henry Payne) shikha.dalmia@reason.org (Shikha Dalmia) — Mon, 31 Dec 2007 14:58:00 EST

The Weekly Standard

Representative John Dingell, the powerful Michigan Democrat, prevented fellow Democrats from slaughtering Detroit auto companies during the recent battle in Congress over the energy bill. But this may be Dingell's--and the Big Three's--last stand as the green revolution overtakes the proletarian revolution among the priorities of the Democratic party.

In the new era, it is American car consumers who will suffer collateral damage--while victory over climate change will remain elusive.

The cornerstone of the energy bill signed Wednesday by President Bush is the raising of so-called Corporate Average Fuel Economy (CAFE) standards to mandate a 40 percent increase in auto fuel efficiency by 2020. First conceived in the wake of the 1970s oil embargo (at a time when global cooling hype was at its peak), CAFE sought to reduce America's "dependence" on foreign oil. But since passage in 1975 the policy has had the opposite effect as better fuel economy made it cheaper for Americans to drive more, increasing U.S. auto fuel consumption 20 percent and imported oil's share of the U.S. market from 35 percent to 59 percent.

Despite CAFE's failure, Washington has opted for the program's biggest expansion in 30 years. Global-warming fever, rising gas prices, and Detroit's declining economic importance conspired to make this CAFE's moment. Though Republican presidents have historically stood against tougher regulations, in this case the Bush administration actually initiated the increase. Desperate to prove his Iraq adventure was not motivated by a lust for oil, President Bush has made curing America's "oil addiction" a domestic policy priority.

But the biggest push for CAFE came from within the Democratic party. Democratic circles once regarded foreign cars as a treasonous assault on American workers. Now, however, Detroit's once iconic carmakers have become environmentally incorrect. Indeed, congressmen Ed Markey (D-Mass.) and Greg Walden (R-Ore.) publicly bragged about owning Toyota hybrids during a recent hearing of the House Select Committee for Energy Independence and Global Warming.

Given this backdrop, Detroit's goal this time was not to dodge stricter CAFE standards--but to minimize their damage. In this the automakers succeeded rather well, thanks to octogenarian John Dingell's unflinching advocacy.

For starters, Dingell not only reinstated the ethanol loophole the Senate bill had scrapped--but he actually expanded it to include other alternative fuels such as biodiesels. The loophole gives automakers fuel economy credits for building vehicles that can run on alternative fuels--whether consumers fill them with these fuels or not. Dingell also bought the industry new efficiency credits. For example, if a company achieved more than the mandated 40 percent increase in fuel economy for its smaller-vehicle fleet, it could apply the balance to its SUVs. And the industry kept differential fuel economy standards for cars and light trucks--instead of requiring that trucks meet the same stringent standards as cars, as the Senate bill, under pressure from environmental groups, had mandated.

But Dingell's special gift to Detroit was his success in forcing a radical overhaul of CAFE standards that is far more favorable to them than their Asian competitors. The original CAFE standards set a fixed standard of 27.5 mpg for cars and 20 mpg for trucks. This amounted to a doubling of fuel economy and disproportionately affected Detroit, which manufactured a fuller range of vehicles than Japanese auto companies, with their specialization in fuel-efficient compact cars.

The new CAFE standards do not set absolute gas-mileage requirements for vehicles. Rather, they require every company to increase its fuel efficiency by 40 percent. This will effectively hold Japanese carmakers to a higher fuel economy standard given that their vehicles get better gas mileage to begin with. Thus, a spokesman for the Alliance of Automobile Manufacturers, Charles Territo, notes that the 40 percent increase will likely translate into an overall 32 mpg for Chrysler vehicles but 38 mpg for Honda.

The Bush administration estimates the new standards will cost the industry $85 billion. Though they may cost Japanese carmakers more, American carmakers will still have a harder time complying given their worse financial situation. But both will have to divert research dollars from cars that consumers prefer.

A recent Consumer Reports survey found that 70 percent of buyers want more fuel-efficient vehicles--but only 50 percent are willing to sacrifice size and performance in that quest. This market reality is why, even as engine efficiency improved 1.5 percent annually for the last 20 years, automakers have channeled those gains not toward better gas mileage but toward greater horsepower. v

The net effect of the new CAFE standards therefore will be to thwart consumer desire as carmakers are forced to overhaul their product lines to emphasize either smaller cars or large hybrid-engine vehicles that, on average, cost $5,000 more than the nonhybrid versions. Jesse Toprak, an auto analyst with Edmunds.com, maintains the 35 mpg mandate is so onerous that large, gas-powered SUVs might well go the way of the dinosaur--despite their popularity and superior safety record.

But will this sacrifice curb climate change? Not really. John Christy, University of Alabama climatologist, maintains that even if the entire world adopted a fuel efficiency standard of 45 mpg, "the net effect would reduce projected warming by about 0.05 degrees Fahrenheit by 2100."

John Dingell bought time for U.S. automakers endangered by the quixotic crusades of climate warriors--but he won't live forever. Their fate will remain precarious, unless cooler heads--or cooler air--prevails.

This column first appeared in The Weekly Standard.

Environmental Timetables Built for Style, Not Substance

skaidra@reason.org (Skaidra Smith-Heisters) — Tue, 12 Jun 2007 15:22:00 EDT

Timetables are taboo in President Bush's strategy for the Iraq war, but in energy and environmental policy, they're as trendy as can be.

Of these, the Kyoto Protocol is perhaps the best-known environmental timetable: under the original Kyoto agreement, by 2008-2012, participating countries were expected to cut greenhouse gas emission levels to (on average) 5 percent below 1990 baseline emissions levels.

More than a dozen U.S. states have already set greenhouse gas emission reduction targets—though no two states have set the same timetable. The most common initial goal—reducing emissions to 1990 levels by 2010—is shared by many of the Northeastern and mid-Atlantic states participating in the Regional Greenhouse Gas Initiative, including Connecticut, Maine, Massachusetts, New Hampshire, Rhode Island and Vermont.

California, seemingly always a trend-setter in environmental regulations, plans to reduce greenhouse emissions to 80 percent below 1990's levels by the year 2050. That number is considered the benchmark by many in the environmental community.

Also popular with policymakers these days are timetables and goals for renewable energy generation by state electric utilities. Twenty-four states and the District of Columbia already have these standards, but again, there are wide deviations in the specifics of each law.

When Oregon joins Minnesota and New Hampshire, as it is expected to soon, the three states will share the same renewable energy standard. Each state will mandate that utilities produce 25 percent of their electricity from renewable sources by 2025, a goal promoted nationally through the "25x'25" campaign of the Energy Future Coalition. The challenge of meeting that goal is different for each state: Minnesota currently has about 3.5 percent renewable energy generation and plans to meet most of the rest of the goal through conservation and wind power; in New Hampshire, where renewable electricity generation capacity is already at 16 percent, the University of New Hampshire predicts that the state will soon be exporting excess wind energy to neighboring New England states.

The 25x'25 campaign loses a little credibility when you notice that the coalition's website still promotes a study it commissioned from the Rand Corporation last year that concluded their renewable sources goals could be achieved "at little or no additional expense." The RAND researchers were forced to withdraw their study when they discovered serious errors in their estimates just a couple of weeks after the report's release.

Abroad, environmental timetables are even more dramatic. Leaders in Iceland have declared their nation will be completely oil-free by 2050. Sweden aims to be oil-free even sooner, by 2020. Norway is drafting plans to be carbon-neutral by 2050, Costa Rica by 2030.

Such goals are rarer domestically, but there are stand-outs here, too: the city of Austin, Texas, plans to be "carbon-neutral" in just over 12 years, by 2020. That will entail powering the city's facilities with renewable energy, converting the city's fleet of almost 5,000 vehicles to electric power and non-petroleum fuels, reducing greenhouse gas emissions throughout municipal operations and providing incentives for individuals and businesses to do the same, capping carbon dioxide emissions from the city's utilities and generating 30 percent of electricity from renewable sources, constructing new homes with energy-saving and energy-generating capability and offsetting the balance of municipal carbon emissions through mitigation projects. Austin Mayor Will Wynn admits that to make it all happen, "We're having to bank on—cross our fingers—technology advances."

If the eye-catching numbers in some of these timetables seem like they're built for style and short on substance, it's because they are.

A case in point is President Bush's so-called "energy security" initiative, cleverly titled "Twenty in Ten." Sounds simple—the U.S. will cut gasoline consumption by 20 percent over the next 10 years. But what is actually intended by the policy is far less concise. Bush says he wants to see the substitution of approximately 15 percent of projected gasoline consumption in 2017 with alternative fuels, plus reduction in gasoline demand through higher fuel economy standards. That would mean holding gasoline consumption more or less steady for the next decade, while supplementing it with fuel derived from corn and possibly coal, and mandating that automakers sell more expensive, more fuel-efficient cars.

Like many of the popular environmental timetables being established right now, it conceals controversial issues—such as what actually qualifies as a "renewable" or "alternative" fuel—under convenient slogans. In terms of practicality, the Sierra Club should support the plan. But Sierra Club Executive Director Carl Pope calls the President's mandate "magic wand stuff."

Mandates based on politics rather than science almost always make better sound bites than they do sound policy.

Participants in the Kyoto climate agreement are infamously off-track for meeting their initial targets. Among western European countries, despite caps intended to stabilize emissions levels, carbon dioxide emissions have continued to grow since 1990 (an increase of 2.8 percent from 1990–2003 according to a World Bank report last month).

Research at the Lawrence Berkeley National Laboratory last year found that renewable energy standards in Arizona, California, Massachusetts and Nevada were plagued with "chronic under-compliance." Meanwhile in Maine, Maryland and other states the renewable energy standards were ineffective because they were set too low to begin with (essentially just supporting pre-existent renewable energy generators, not increasing renewable energy generation).

And while objective measurement of environmental progress is laudable, there is bias written in to even the simplest of measures, such as the selection of 1990 as a baseline for greenhouse gas emissions inventories in California. Consider that in 1990, California was at its peak in terms of its share of the national economy, while the Soviet Union was on the brink of collapse.

When you start to look at these energy goals practically, things get really dicey. If the United States, as a whole, committed to the greenhouse gas emissions reduction target set in Sonoma County, California—ratcheting down emissions to 25 percent below 1990 levels by 2015—we would need serious help or risk serious economic consequences. The last time U.S. emissions were at that level was in the mid-1960s.

In 1967 the U.S. population was just passing the 200 million mark. In 2015, the U.S. population is expected to be 325 million. That means that in just the next few years, we'd need to fit a population almost two-thirds bigger, and a Gross Domestic Product more than four times bigger (real GDP in 1967 was $3.5 trillion; in 2006 it was $11.6 trillion, 2015's GDP is projected in the range of $15 trillion), into a carbon footprint we outgrew 40 years ago. (In this case, that carbon footprint—the measure of all our activities in terms of the amount of greenhouse gas produced—doesn't even account for the carbon-intensive industries we rely on outside of the United States, sort of like weighing ourselves without both feet on the scale.)

Clearly, these kinds of timetables offer powerful inspiration, but the rhetoric often has little relationship to either strategy or practicality.

The rising consciousness concerning global environmental issues has generated a welcome surge in long-term thinking about natural resources and our economy, and moved political leaders to stake unprecedented bold claims in the frontier of the future. However, with timetables for mandates stretching not just past the current administration's tenure but to 2025 and beyond, it will be vitally important to extend the timeline for accountability to match our ambition.

Cow-dung Economics Guide California's Oil Tax Initiative

shikha.dalmia@reason.org (Shikha Dalmia) — Fri, 29 Sep 2006 00:00:00 EDT

Reason.com

Vinod Khosla, the Indian American co-founder of Sun Microsystems, is a general partner at Kleiner, Perkins, Caufield & Byers and the founder of the VC firm Khosla Ventures. He has been named as the country's top venture capitalist by Forbes and Fortune. A prominent ethanol proponent, he is currently co-chairing the campaign for California's Proposition 87, a ballot initiative to create an oil extraction tax.

Dear Vinodji,

You recently jumped into the political fray by putting Proposition 87—the ballot initiative that would tax oil companies to fund research on alternative fuels—before California voters this November. But desis (Indian émigrés) like you and me typically keep a healthy distance from the world of politics, preferring to bury ourselves in our bourgeois existence of work, family and two-and-a-half-car garages (O.K., you probably have a bigger garage). Having lived under the likes of Indira Gandhi, whose Machiavellian machinations make Karl Rove look like Forrest Gump, we have a deep and well-founded revulsion for politics. You might better serve your adopted state and your cause—energy security—by sticking to these desi instincts.

Inviting the government to meddle in the affairs of private business is never a good idea, and if anyone should understand this, it is you. You reportedly left your country because of its hostile business environment and thrived spectacularly in this land of (semi) free enterprise, co-founding Sun Microsystems—one of the most successful computer companies on the planet. Fortune magazine has anointed you the "greatest VC (Venture Capitalist) of all time" because you invested in internet start-ups like Google when everyone else was still nosing through card catalogues.

Now you have become the prophet of alternative fuels that, you believe, are going to revolutionize the energy industry, much as the internet revolutionized communications. You are impatient to cut by half President Bush six-year timetable to bring cellulosic ethanol produced from farm waste to the market.

But, with all due respect, even a man of your stellar track record can't simply will markets to do his bidding; an economy is not a machine that can be manipulated according to its maker's grand designs.

If it were, India's central planners would have made rivers of energy flow into every Indian home. Instead, growing up, we endured chronic power droughts. In scorching summer months, we went hours every day without power, unable to coax an ice-cube out of our lifeless refrigerators to soothe the "prickly-heat" burning our necks. Our dads would wait for hours in long queues to buy a few liters of exorbitantly priced petrol while our moms cooked dinner by candlelight in sweltering kitchens. And we were among the privileged ones living in cities like New Delhi where houses were powered by government-owned thermo- or hydro-electric plants. Villages, if they were lucky, got subsidies for their very own gobar gas plants that supplied homes with methane produced by decomposing dung—India's equivalent of farm-waste ethanol. Every Five Year Plan contained rosy projections of when all of India's villages would have gas and electricity generated from gobar or other renewable energy sources. The results? Per capita energy consumption today remains about a third of the world average, meaning that Indians are on an energy-starvation diet.

Granted, you are not advocating a total government takeover of the energy sector as in India. But the combination of taxes, subsidies and mandates you are proposing has striking similarities to India's socialistic approach—and will produce similar results.

Proposition 87—which you are personally spending $1 million to promote—would force oil companies to pay taxes (or royalties, as you call them) for drilling privileges until the state has raised $4 billion for seed money toward alternative fuel ventures. You argue that California is the only state that does not collect drilling royalties, something that oil companies can well afford to pay given their "abnormally" high profits. But California imposes all kinds of other taxes that make its oil among the highest taxed in the country. Proposition 87 would raise these taxes another 50 percent, forcing Californians, who are already paying among the most exorbitant gas prices in the country, to forego energy consumption.

Yes, I know, your proposal would ban Big Oil from passing on the additional taxes to oil consumers. But who are you kidding? Enforcing the ban would require armies of state auditors to dissect in intricate detail the accounts of oil companies. Regardless of whether they are actually deployed, the potential for harassment will prompt oil companies to flee California just as you fled India, leaving the Golden State not with more energy sources as you intend, but fewer. (Full Disclosure: Oil companies are among thousands of supporters of my employer, Reason Foundation, a non-profit think tank. Their contributions comprise less than 1 percent of Reason's annual revenue.)

The irony is that your proposal to shackle California's oil industry comes precisely when India is unshackling its own. Just when you are trying to replace foreign oil with home-grown fuels in the name of energy independence (a misguided goal), India is renouncing its autarkic energy policies and courting foreign oil companies. Furthermore, even as you are advocating taxes on oil to subsidize alternative fuels, India is scrapping its two-decade-old policy of pricing "luxury" fuels such as petrol above market rates to subsidize "basic" fuels such as kerosene.

Some commentators have suggested that your support for Prop 87 is a rent-seeking move, meant to boost your recent investments in ethanol by debilitating competitors. I don't buy that. Yet, the issue is, if ethanol has all the advantages you says it does—if it is renewable, cleaner, less volatile, more reliable, easily transportable etc.—surely you of all people could convince enough investors to cough up the $4 billion that Prop 87 would raise. Are you not turning to taxpayers because you don't want to assume that kind of risk—and can't convince fellow investors to either? That is hardly socially responsible. CEO Richard Branson recently volunteered to divert the entire $3 billion profits from his carbon dioxide-spewing Virgin transportation empire into alternative fuels aimed at combating global warming. He is putting his own money—not someone else's—where his mouth is.

Indeed, in my view, private investors like you who are accountable to shareholders—or philanthropists like Branson who are spending their own money—are likely to do a far better job of picking winners among new fuel technologies. Entrusting a government board answerable to political interests, as Prop 87 is proposing, has a gobar-gas like odor to it.

Where oil companies have used the government to create barriers or tipped the playing field against alternative fuels, we should fix that. (And, no, it is not an illegitimate barrier, as you claim, when oil companies don't install enough E-85 pumps in gas stations to distribute ethanol; not carrying products that don't maximize your profits is not the same as impeding others from offering those products). Let's end today the billions of dollars they receive in corporate welfare every year, for instance.

Your cause might involve very cutting-edge technologies, but you are promoting it with curiously outmoded economic thinking. It might be worth questioning your Prop 87 crusade by revisiting the lessons of failed policies from home.

Your compatriot expatriate,

Shikha

Stop Playing Politics With Energy

skaidra@reason.org (Skaidra Smith-Heisters) — Sun, 06 Aug 2006 00:00:00 EDT

Orange County Register

With gas prices over $3 a gallon and natural gas prices soaring because of Hurricane season, Congress is once again trying to look like it's doing something to lower gas and oil prices.

The Senate just approved a bill that would lift the 25-year moratorium on offshore oil and gas drilling in 8.3 million acres of waters off of Florida in the Gulf of Mexico. A House bill passed earlier this year would go much further by ending the federal ban on drilling in coastal areas.

Neither bill would change California's long-standing bipartisan prohibition of expanded offshore drilling, but Gov. Schwarzenegger has come out forcefully against the federal maneuvering anyway. As we near November's election, Arnold is out to put as much distance as possible between him and the unpopular Bush administration, recently publicly deviating from Republicans on oil drilling, stem cell research, California's national forests, and global warming.

In this case, Schwarzenegger can take his cue from opinion polls, which show a majority of Californians strongly oppose offshore drilling, and a whopping 90 percent of likely voters rank environmental policy as important. Seventy percent rank the coastal environment as very important to quality of life in the state.

But the state's energy future issue deserves more than political gamesmanship and believe it or not, Congress may actually be onto something here.

California's offshore oil and gas resources are thought to be relatively small, but our demand is undeniably large. Worldwide, California consumes more natural gas than all but a handful of countries, ranking tenth in worldwide consumption. And Gov. Schwarzenegger's proposed "Hydrogen Highway" would rely extensively on natural gas, increasing the state's needs.

Further complicating matters, California 's policy on natural gas looks more like a split-personality disorder than an environmentally sound energy strategy. We mandate the use of relatively clean natural gas for more than half of our electricity generation, but we severely restrict its production. We also pay the highest natural gas prices in the world.

The US is the only country that bans ocean production of natural gas. Natural gas prices are based on local supply constraints to a much greater degree than oil prices are, and development of more domestic sources would likely bring real benefits in terms of lower prices.

It has been nearly 40 years since negligence in operations by Union Oil Company, which would have been illegal under California law even at that time, caused the tragic oil spill off the coast of Santa Barbara, damaging miles of beach and galvanizing public opinion against offshore drilling.

It is right that we remember this preventable failure, but it is irresponsible not to view it in light of modern knowledge. Oil and gas exploration off our shore can benefit from California's advanced technological capabilities and strict environmental oversight.

In the last couple of decades, oil drilling operations in California's state waters have had significantly better safety records than oil drilling rigs located in federal waters farther out or than oil tanker operations, where regulatory oversight is often either lax or inconsistent. For perspective, since 1969, rigs in California waters have spilled fewer total barrels of oil than what bubbles up from natural oil seeps in the Santa Barbara area in one week.

As for today's technology, natural gas platforms in the Gulf of Mexico were strong enough to largely survive the devastating combination of Hurricanes Katrina and Rita last summer, suffering only minor damage and temporary production disruptions.

California's coastline is undoubtedly best protected by Californian control of offshore oil and gas resources. Politicians and environmentalists should learn from the approximately one-quarter of federal wildlife refuges that have supported oil and gas operations as well as successful offshore operations in California, Canada and Europe to set clear environmental performance goals, and task industry with innovating to meet those standards.

If we are going to embrace the role of natural gas to help achieve our goals of reducing greenhouse gases and other emissions, promote energy self-sufficiency and reduce our dependence on foreign oil, then the state must make an honest assessment of our deep ocean energy resources. How much natural gas is out there? What are the benefits and trade-offs of using it? Otherwise, simply playing politics will lead to another environmental tragedy: an energy policy based on willful ignorance.

Skaidra Smith-Heisters is an environmental policy analyst at Reason Foundation, a free market think tank. An archive of her work is here. Reason's California-related research and commentary is here and Reason's energy research and commentary is here.

Gas Prices, Fuel Efficiency Follow the Market

sam.staley@reason.org (Samuel Staley) — Mon, 15 May 2006 00:00:00 EDT

We're in a political version of silly season with hilarious jockeying over what to do about oil imports and gas prices.

President Bush is claiming we are "addicted" to foreign oil. Congressional Republicans floated, then quickly killed, a politically contrived tax rebate plan to "ease the burden" of higher gas prices. And both Republicans and Democrats on Capitol Hill are calling for investigations into price "gouging". They're also talking about reducing the gas tax, sapping away precious revenue needed to shore up a notoriously under-funded transportation network.

We've been through this before. The 1970s saw spikes in world oil prices as Middle East nations tried to choke off America's economy. The early 1980s saw domestic gas prices spike again as we deregulated oil price controls. Watching these political shenanigans in 2006, it's clear our leaders haven't learned the lessons of history or basic economics.

The basic premise of economics is that prices go up if one of two things happen: demand increases while supply stays the same, or supply goes down while demand stays the same. These relationships are so well known that most social scientists—even the liberal ones—don't question them.

Yet, watching politicians in Washington and our state houses wallow over what do to about gas prices, makes it clear they don't grasp the laws of supply and demand.

Hawaii gets the prize for historical and economic ignorance, however. There, Republican and Democratic legislators imposed caps on gas prices eight months ago. The Hawaii law, however, added a twist. Instead of regulating retail prices at the pump, Hawaiian politicians regulated wholesale prices. Not surprisingly (to economists or historians), the wholesalers passed on their costs to the service stations.

The result?

Prices rose. And fast. One estimate by the Hawaii Department of Business, Economic Development, and Tourism placed the eight month cost to Hawaiians at $55 million. Fortunately, the legislature realized its error, relearned basic economics the hard way, and ended the program earlier this month.

Of course, all this political angst was unnecessary even if Hawaiians didn't believe economic theory. All they had to do was look at history.

The energy crises of the 1970s, combined with deregulation of oil prices, contributed to a doubling of gas prices in the early 1980s. But then prices stabilized, and even fell slightly during the early 1990s before beginning to rise again in 1999.

How did consumers respond? Just as economics professors predicted they would. As prices went up, they conserved. They did it first, as they are now, by driving less. Then, as they realized the higher prices were permanent, consumers changed what and how they drive.

Average fuel consumed per vehicle dropped 14 percent in the 1970s and another 10 percent between 1980 and 1985. Average fuel consumed per vehicle has remained remarkably stable since then, reflecting the stability of gas prices during that period.

Meanwhile, we started driving more fuel efficient vehicles. In 1980, we were sputtering along traveling just 13 miles per gallon. By 1997, we were traveling 17 miles on each gallon of gas. That's an increase of almost a third.

Competition helped this along, too. In 1980, imported passenger cars averaged almost 30 miles per gallon and the average domestic car clocked in at just 23 miles per gallon. By 2000, the two groups had reached parity at about 29 miles per gallon. Gas, as a share of the total costs of driving a car, has fallen from 28 percent in 1980 to 12 percent in 2004.

What's the takeaway for U.S. policymakers and citizens? If we're serious about conserving oil, the best policy is to let markets work. Consumers respond to higher prices, and that spurs efficiency improving technology.

We haven't seen much change in recent years because gasoline prices have remained remarkably stable since the mid-1980s and 1990s. General inflation, housing, and medical care costs have all grown substantially faster than gasoline prices until about 2002.

So, part of what consumers are responding to now is the "shock" of a rapid, unexpected rise in gasoline prices. Consumers don't really know if these price increases are permanent or temporary. They're reluctant to make wholesale changes in their driving.

This will change with time. Politicians should be patient, and let markets drive changes in technology and fuel efficiency. They have a much better track record than the silly and economically na�ve policies currently gracing the headlines of newspapers and evening news programs.

Samuel Staley, Ph.D., is director of urban growth and land use policy at Reason Foundation. An archive of his work is here and Reason Foundation's energy research and commentary is here.

Defend America, Buy More Iranian Oil

shikha.dalmia@reason.org (Shikha Dalmia) — Fri, 05 May 2006 00:00:00 EDT

As the nuclear stand-off with Iran helped push oil prices to near-record levels, President Bush once again declared, "Dependency on oil creates an economic problem for us, and it creates a national security problem for us."

But if Iran's behavior makes the case for anything at all, it is that America should become more — not less — "dependent" on foreign oil. In fact, the best way for America to defuse the so-called Middle Eastern oil weapon is by purchasing even more oil from the region.

The economic case for energy independence has always been nonsensical. It is not possible to shield American consumers from rising prices at the pump simply by replacing foreign oil with domestic oil. Why? Because regardless of where the oil is produced — Oman or Oklahoma — its prices are set by the global market.

The global demand for oil and its ease of transportation have synchronized oil prices everywhere. Therefore, unless compelled by draconian government mandates, no American company that can command $3 a gallon in Oman would sell it for much less in Oklahoma. If war prevents Middle Eastern oil from reaching its global customers, the incentive for American companies to sell U.S. oil overseas would be even greater given the higher prices that it would fetch. War or peace, no amount of domestic production will give us "independence" from the law of supply and demand.

But if domestic production won't ensure access to cheap oil, some believe that it will at least shield us from the kind of geo-political manipulation that Arab countries attempted during the 1973 oil embargo. That, however, is also a myth.

For starters, OPEC — the Arab-dominated cartel of oil producing nations — did not succeed in its manipulation even then. It lifted the embargo in less than two months, once it became clear that while its members were giving up oil revenues, its oil was still reaching the United States because of diverted shipments from Europe. There was some diminution of oil supply in the United States, but not nearly enough to do any serious damage to the American economy.

The long lines outside gas stations that Americans associate with the embargo resulted more from panic buying and domestic oil price controls rather than lost Arab oil, notes M.A. Adelman, a professor of economics at the Massachusetts Institute of Technology.

But if all OPEC countries together couldn't pull off their political blackmail, a rogue regime acting alone will surely not succeed.

Saudi Arabia's experience in 1980 demonstrates why. The country elected to play the role of OPEC's "swing producer," unilaterally limiting its oil production in order to boost world oil prices. It expected that higher oil prices would compensate it for lower oil sales.

But Saudi Arabia was forced to abandon its policy in a few years as other OPEC members bumped up their production on the sly and pushed its exports to nearly zero. Since then, Saudi Arabia has repeatedly said that it would never again unilaterally cut output.

The lesson of Saudi Arabia's experience — oil sales that one producer foregoes will quickly be captured by others — is not lost even on regimes such as Iran, especially now when there are more oil suppliers than ever before.

Given Iran's defiant mood and tension with the U.S. and Europe over its nuclear program, one would have thought that this would be a perfect moment for its hot-headed president to further escalate — if not act on — his threat to cut off Iran's oil exports to the West and shut down oil shipments through the Straits of Hormuz.

But beneath all of Iran's saber-rattling and its threat to retaliate against Israel in the event of a U.S. attack, it realizes how suicidal such a move would be. During a recent OPEC meeting, Karem Vaziri Hamaneh, Iran's oil minister, went out of his way to reassure the world that Iran had no intention of disrupting the oil market. "The need of the world for energy is soaring and, if Iran is taken out of the equation, prices will shoot up," he told the Wall Street Journal. "But we don't want to cause hardship for any consumers around the world."

Vaziri's concern is not so much for the world's oil consumers, of course, as for the economic consequences for his own country. The Iranian government depends on oil exports for nearly half of its total revenues. If it cuts these exports, buyers could go to other suppliers. But there is not much else that Iran could sell to other countries to replace its lost oil revenues.

Our dependence on Middle Eastern oil is only the flip side of their dependence on our purchases. But given the narrow base of Middle Eastern economies, the power in the relationship is firmly on the side of the oil buyers. If that relationship were to end because of "energy independence," we would give up crucial leverage to control the worst behavior of some of the world's worst regimes. Of course, this leverage is no magic wand that would protect us from a totally irrational regime willing to absorb the economic cost of using the oil weapon. But the more oil we get from such a regime, the higher the price it would have to pay.

Thus whatever other arguments there might be for boosting domestic oil production, national security is not one of them. While this might seem counter-intuitive, it is really part of the overall logic of trade: The mutual dependence that trade breeds fosters peace because it gives hostile trading partners an incentive to refrain from acting on their hostility. Energy independence would weaken that incentive.

Shikha Dalmia is a senior analyst with Reason Foundation.

Republicans and Gas Prices: Look in the Mirror

sam.staley@reason.org (Samuel Staley) — Wed, 26 Apr 2006 00:00:00 EDT

Watching Republicans jockey for a lead position to bash oil companies and rein in gas prices is-well-bizarre.

President Bush, House Speaker Dennis Hastert, R-Ill., and Senate Majority Leader Bill Frist, R-Tenn., have all promised to investigate price gouging, though they know that isn't what is driving up gas prices. And Republican Sen. Arlen Specter, R-Pa., wants to tax the "windfall" profits of oil companies.

Of course, I gave up the notion that Republicans stand for free markets long ago (see steel, lumber and fish tariffs and farm subsidies under Bush for a few of the more recent reasons). As politicians think about the next election, which is always just around the proverbial corner, they are all too willing to trade free market principles for political expediency.

But the saber rattling over high gas prices is taking political chutzpah to another level. Republicans are asking oil companies to financially disembowel themselves over a supply disruption they largely created. And that's why the politics surrounding oil and gas prices is so bizarre.

Gas prices have soared, rising 25 cents in just two weeks and breaking the $3 per gallon psychological ceiling in many cities.

But, this begs the question: What's causing prices to drive up?

One factor is the rising demand that always comes with summer. Gas prices spike in the spring regardless of who's in charge. We tend to drive more in the summer as we go to the beach or lake, visit relatives, or cruise in the countryside. So, prices increase (as they are supposed to) to keep demand in line with current supplies.

Another, more important factor, is a cumbersome transition to a summer gasoline mix that includes ethanol. The transition is longer and more difficult than usual since suppliers are replacing MTBE, an additive that is now banned in several states because it can leak into water supplies. Ethanol, unlike MTBE, cannot be delivered by pipeline and mixed into gasoline at refineries. Instead, it is delivered by truck, rail, or barge and mixed with gasoline at regional distribution terminals.

This has introduced temporary, scattered logistics problems. For example, tanker trucks that would normally be used to deliver gasoline to filling stations are being diverted to deliver ethanol to terminals. Also, terminal owners must completely drain their tanks and pipes of MTBE-laced gasoline before switching to ethanol. The result? A temporary shortage of gasoline for retailers which drives up the price.

The third and most important factor, is what pundits are calling "geopolitical uncertainty."

We are at war in Iraq and still have troops in Afghanistan. Iran wants to rattle our bones by going nuclear and the world is wondering if we will militarily strike them to prevent it. Throw in an anti-Bush politician in charge of Venezuela (our fifth largest supplier of crude oil in February) and the political instability in Nigeria (our fourth largest supplier of crude oil in February) and at least one-fifth of the price of a barrel of oil on the world market is attributed to geopolitical uncertainty according to oil industry analysts.

That means two of the three drivers of today's higher gas prices —the ethanol mix and geopolitical uncertainty—are policy-driven. Guess who's in charge of federal policy? Republicans.

So, here's what the oil companies face: gas prices usually spike a bit before the summer as the market's way of keeping us consumers in line with the supply of gasoline. But, on top of this, federal policymakers have infused loads of uncertainty and new costs into the oil and gas industry by helping create today's highly charged international political environment.

What would happen if we taxed these revenues away? Well, when a windfall profits tax was imposed on the oil industry in the 1980s, investment in domestic oil research, development, and exploration plummeted. We became even more vulnerable to shifts in world oil supplies and disruptions in the energy supply chain.

A windfall profits tax also won't topple a Venezuelan president, stabilize Nigeria, rebuild Iraq, or keep Iran from going nuclear.

So, here we sit, waiting for President Bush to launch an "investigation" into higher gas prices.

If you are upset about high gas prices, you're going to benefit more by selling your SUV and buying a hybrid than you will a Congressional investigation. Let the market sort itself out.

If federal policymakers really want to calm oil markets and bring gas prices down, their efforts would be far better invested in stabilizing the Middle East and creating a more certain, trade-friendly international economy and political environment.

Presidential Energy

rbailey@reason.com (Ronald Bailey) — Thu, 02 Feb 2006 00:00:00 EST

The Wall Street Journal

"America is addicted to oil," President Bush warned during his State of the Union address, vowing "to replace more than 75% of our oil imports from the Middle East by 2025." And since our 230 million cars and trucks burn two-thirds of the 20 million barrels of oil we consume daily, Mr. Bush solemnly declared, "We must also change how we power our automobiles." The cure for our addiction? Why, a government program, of course: the Advanced Energy Initiative. This new scheme would throw more tax dollars at research aimed at creating clean power plants and also cars powered by hydrogen, electricity and ethanol. Unfortunately, the past 35 years of failed presidential energy initiatives doesn't bode well for these proposals.

For example, during the 1973 Arab oil embargo -- which tripled the price of oil overnight -- Richard Nixon launched Project Independence, asserting, "In the year 1980, the United States will not be dependent on any other country for the energy we need to provide our jobs, to heat our homes, and to keep our transportation moving." Like Mr. Bush, Nixon also promised federal dollars to produce "an unconventionally powered, virtually pollution-free automobile within five years."

Gerald Ford moved the date for achieving American energy independence up to 1985. In 1975, Mr. Ford signed the Energy Policy and Conservation Act, which set federal standards for energy efficiency in new cars for the first time.

In 1977 Jimmy Carter notoriously declared energy independence an issue of such vital national interest that it was the "moral equivalent of war." In August of that year, Mr. Carter signed the law creating the U.S. Department of Energy, intended to manage America's ongoing energy crisis. In a nationally televised speech in July 1979, after the Iranian oil crisis doubled oil prices, Mr. Carter swore, "Beginning this moment, this nation will never use more foreign oil than we did in 1977 — never." He proposed a sweeping $142 billion energy plan which would achieve energy independence by 1990, moving the date forward yet again. Mr. Carter also urged Americans to park their cars one day a week and take public transportation.

In 1991, in the prelude to the first Gulf War, George H.W. Bush announced a national energy strategy aimed at "reducing our dependence on foreign oil." He also funded the U.S. Advanced Battery Consortium — a $260 million research project to develop lightweight battery systems for electric vehicles.

In 1992, Bill Clinton proposed a tax of 59.9 cents per million BTU on crude oil to discourage dependence on foreign oil. Next year he launched the $1 billion Partnership for New Generation Vehicles with the Big Three automakers, aiming, by 2004, to produce a prototype car that was three times more fuel-efficient than conventional vehicles.

Now we return to the current administration. In May 2001, after California experienced a series of rolling blackouts, Dick Cheney's national energy task force starkly declared: "America in the year 2001 faces the most serious energy shortage since the oil embargoes of the 1970s." In his 2003 State of the Union message, President Bush pledged "to promote energy independence for our country." He also announced his $1.2 billion FreedomCAR proposal, to develop hydrogen-fueled vehicles.

But despite these bold proclamations, the only way we've ever cut back on imported oil is in response to higher prices. World oil prices peaked in real terms in 1980 at about $90 per barrel. In 1977, U.S. imports were 6.6 million barrels per day. By 1985, imports had been cut in half to 3.2 million barrels. Why? Simple economics: Higher prices boosted domestic production and reduced consumption. And despite more than 30 years of government-sponsored initiatives only about a half-million alternative fuel vehicles roam America's highways, and none are wholly electric or hydrogen powered. Today's higher prices will do far more to free us from dependence on foreign oil imports and spur energy technology innovation than any federal program ever will -- even a so-called Advanced Energy Initiative.

Ronald Bailey is Reason magazine's science correspondent.

[Correction: In 1992, Bill Clinton proposed a crude-oil tax of 59.9 cents per million BTU. The original version of this article said the tax was 59.9 cents per BTU.]

Katrina Reveals Gas Price Folly

adrian.moore@reason.org (Adrian Moore) — Thu, 01 Sep 2005 00:00:00 EDT

Orange County Register

With oil and gas production in gulf states at a standstill in the wake of devastating Hurricane Katrina, oil prices hitting a record $70 per barrel, and an average gasoline price of over $2.60 a gallon, the Bush administration has decided to tap the nation's Strategic Petroleum Reserve.

The move comes amid numerous predictions that gas prices will shoot up over $3 per gallon throughout California this Labor Day weekend. Bloomberg News reports that Katrina forced the temporary closure of at least eight refineries, responsible for as much as 10 percent of the nation's oil production.

The ongoing fallout from Katrina sheds light on our woeful energy policies, demonstrating that we are so vulnerable that even a temporary shutdown of oil refineries in one corner of the country will have a huge impact on gasoline prices across the country and in California.

Why? Supply and demand. And not simply the supply of oil we get from the Middle East, Venezuela, and others.

A new oil refinery has not been built in the United States since 1976. During that time, our gasoline use has increased over 25 percent. The nation's 149 existing refineries have been running at maximum capacity trying to meet record demand and, as a result, not only do we import oil, we actually have to import 10 percent of our daily gasoline from refineries overseas.

So when Hurricane Katrina or a refinery fire or anything else causes even just a few refineries to shut down for awhile, there is absolutely no excess capacity nationwide to make up the difference, and prices at the pump skyrocket.

For the wealthiest, most powerful nation in the world this is a ridiculous situation that will only get worse as our insatiable demand for gasoline keeps growing and refinery capacity falls further behind in the coming years.

Just a few new refineries would alleviate the problem and help keep our gas prices lower and steadier.

But getting an oil refinery built is next to impossible, hence the 30-year construction drought. There will always be environmental activists who fight any new proposed refinery, regardless of where it might be located and how environmentally safe it is. And our environmental rules give them the upper hand.

The environmental impact-report process mobilizes the "not in my back yard" elements to oppose any proposed refinery, but it does not mobilize people or groups who are looking at national energy needs. You wind up with a very lopsided discussion where potential problems are thoroughly and perhaps overly represented, but the only group pointing out the benefits of the refinery is the "evil" oil company asking to build it — even though every automobile driver would benefit.

Consider the example of Arizona Clean Fuels, which has been trying to build a small refinery outside Yuma for almost 10 years. It took five years just to get air-quality permits. Now they hope to be operational in 2010, 15 years after they started the project.

President Bush recently signed a new energy bill that tries to make it easier to build new oil refineries, especially in areas with high unemployment — where the new jobs would likely be welcome. And yet, special-interest groups decried the provision as an environmental and public health injustice, arguing that these communities won't want refineries but won't have the political power to fight them off.

The opposition to building new refineries ignores the dramatic technological improvements that have been made since an oil refinery was last constructed here in 1976. New, clean refineries emit far less pollution than older refineries, with new scrubbers and design changes that dramatically reduce sulfur and other emissions. And at the same time our ability to model and map emission characteristics and distribution lets us choose the best locations for new facilities — where they will have the least possible impact on people and the environment.

Even as gas prices have soared beyond $2.50 per gallon in many parts of the country, Americans have not stopped driving. We might tighten our budgets elsewhere to make up for the added expenses, but we show no signs of giving up our cars. At some point, we need to admit our dependence on gasoline and add the capacity and refineries that will help lower gas prices.

Our environmental review process needs to embrace local concerns and impacts, but it can't facilitate the "not in my back yard" resistance that completely derails plans for any new refineries.

Hurricane Katrina has revealed an ominous weakness in our energy policy. If we don't start building refineries and adding capacity to handle our growing gas needs, it won't take a natural disaster to send gas prices soaring even higher.

Adrian Moore, Ph.D. is vice president of research at Reason Foundation.

Jolted by Gas Prices? Don't Be Too Quick to Cuss Refiners

david.nott@reason.org (David Nott) — Thu, 24 Jun 2004 00:00:00 EDT

Los Angeles Times

Despite record profits and high gasoline prices, Shell Oil Co. plans to close its Bakersfield refinery in October. It produces 2% of California's gasoline and 6% of its diesel fuel, which means an already tight fuel market is about to get even tighter. Drivers throughout the state are blaming Shell, but the real villain is the state's burdensome regulations and punitive taxes.

With refineries running at 96% of capacity nationwide, simple scheduled maintenance at a plant can produce a price hike at the pump. And yet no new refineries have been built in this country since 1976; no new California refineries have been built in 35 years. On the contrary, since 1981 the number of refineries nationally has shrunk from more than 300 to half that many. The single biggest reason for the decrease in refineries is that extreme environmental regulations make it almost impossible for oil companies to build new facilities. Do you want one in your neighborhood? No one else does either. Never mind that you smell more gasoline at a filling station than at your typical refinery, thanks to improvements in technology and equipment.

Oil companies also want to limit their exposure and liability in overzealous lawsuits and attacks from the Environmental Protection Agency. In 1994, an independent contractor accidentally damaged a pipeline, leaking large amounts of oil into the Skagway River in Alaska. Edward Hanousek, a manager for the project, was off duty and nowhere near the accident at the time. Nevertheless, he was charged with two federal crimes and sentenced to six months in prison. The threat of lawsuits drives refineries, which are at higher risk, out of business.

When the government isn't prosecuting employees, it is creating laws to make gas more expensive. Regulations requiring reformulated gasoline are making many older refineries obsolete, and California has special regulations that are different from the rest of the country. As Congress passes pork projects that benefit individual members' home districts — like federal ethanol mandates that put corn-based products in our gas (great for Midwest farmers, terrible for drivers) — it makes producing gasoline more complicated and thus more expensive.

And then there are the taxes. We often forget about gas taxes at the pump because we see just the per-gallon price. In California, the per-gallon price includes more than 50 cents in federal, state and local taxes (all states collect 18.4 cents per gallon in federal taxes) — a full 8 cents higher than the national average, according to the American Petroleum Institute. Let's stop padding the state coffers.

Without the taxes, paying $1.50 for a gallon of gas would seem like a steal considering that the oil is shipped by tanker from the Middle East or another faraway place, refined and then trucked to the pump. A gallon of Evian water costs $6, well more than a gallon of gasoline.

There also is the matter of Shell's ultimate goal — to make money. Last I checked, there's nothing wrong with that. Shell is making the same decision that many other companies have made — to scale back California operations and move to states that welcome their business. California has more regulations, higher taxes, higher workers' compensation costs and higher labor costs than almost anywhere else in the country. Until that changes, we will continue to see other firms do the same.

I lived the first 30 years of my life in Bakersfield. When you drive down Coffee Road, you can still see the abandoned Tosco refinery. When it closed, my cousin lost his job there. You can see the signs of change and evolution in the oil industry in which I also worked. Life moves on, and so will businesses in this overly regulated climate.

David Nott is the President of Reason Foundation. He is also a registered professional petroleum engineer in California and worked for Shell from 1986 to 1994.

The Price Isn't Right

info@reason.org (Lynne Kiesling) — Wed, 25 Jun 2003 00:00:00 EDT

Suddenly politicians in Washington are concerned about a natural gas crisis. Indeed, Energy Secretary Spencer Abraham has convened the National Petroleum Council to discuss the matter on June 26 in Washington. Current natural gas prices are high — more than double their low prices five years ago — and futures prices indicate that natural gas supplies are likely to continue tight in the short run. Does that fact mean that we have a full-blown energy crisis and require government action? Maybe; but not the price caps that have been the frequent remedy for high prices in this and other industries.

First, some history. Natural gas markets have been largely deregulated since the late 1970s, after some initial fits and starts. Deregulation unleashed previously unknown value creation that benefited consumers and producers alike. As a consequence, by the 1990s natural gas was widely available at very low prices, so low, in fact, that some producers went out of business or confined their extraction to well-known deposits. This price and profit cycle has historically been lamented in the industry.

Another constructive development since natural gas deregulation has been the creation of thick, liquid, sophisticated financial markets for natural gas. Futures, options, puts, calls, and more complex derivatives — all have enabled risk spreading in natural gas markets. The ability to hedge risk across time and across different market conditions has substantially decreased the volatility in natural gas prices.

So, with this happy story of the ability of market processes to create value and stem price volatility, why this increase in natural gas prices? The price increase is not as sudden as has been the political realization of it. Natural gas prices have been increasing since the late 1990s. It is also, not surprisingly, the consequence of the interaction of demand, supply, and forces that shape demand and supply.

Many analysts and energy industry experts have, correctly, pointed to supply restrictions as the prime cause of the rigidity of natural gas supply. In particular, they argue that limitations on drilling on federal lands, in consideration of the environmental amenities attached to those lands, have constricted potential exploration options. Such limitations do indeed make supply more inelastic.

However, an emphasis on constrained domestic supply works in conjunction with the very important role that demand has played in increasing natural gas prices. Environmental regulations, formulated largely in the 1990s and in the wake of natural gas deregulation, are premised on the fact that natural gas is a clean and cheap fuel for electricity generation, particularly relative to bituminous coal. Based on that presumption, air quality regulations have led to a situation in which the only economical way to build new power plants is to fuel the facilities with natural gas. Furthermore, improvements to existing plants that have occurred in the past 30 years have overwhelmingly used natural gas to comply with the new source review regulations introduced in the early 1970s.

This focus on natural gas as the way to achieve air quality improvements without dramatically increasing power generation costs has had an unfortunate, and likely unforeseen and unintended, consequence of reducing the resiliency of natural gas markets. Regulatory mandates have constrained us away from being able to apply the lessons of portfolio diversification to our energy choices, and our inability to diversify our fuel input portfolios makes for markets that do not adapt to unanticipated and changing conditions. This is a very high price to attach to the environmental amenities of improved air quality, air quality that could conceivably have been achieved through other means had the regulations not so specifically stipulated natural gas as the fuel input.

The potential implementation of the Kyoto Treaty compounds and exacerbates this costly balkanization of fuel portfolios. Even if the U.S. does not ratify the treaty, imagine the consequences of Canada's implementation. Canadian electricity generators would have to substitute into natural gas as they reduce their use of coal to meet the carbon dioxide reduction targets. If Canadian demand for natural gas increases to fuel their own power needs, then barring a substantial increase in Canadian drilling, there will be much less Canadian natural gas available for export to the U.S. Most of our imported natural gas comes from Canada, so the dislocation to the U.S. natural gas market would be staggering.

I started by suggesting that some government action could forestall this impending "crisis". Unlike those who would recommend price caps and other forms of regulation to control prices, I suggest that government officials seek out further deregulation that would make energy markets more robust and resilient. Some of the required action is straightforward — remove existing obstacles to fuel substitution and to the importation of liquefied natural gas (LNG). In fact, retooling existing terminals to take some small LNG imports would be a low-cost first step toward creating integrated global natural gas markets. Construction of new LNG terminals can take up to a decade, taking into account siting and environmental regulatory processes, so imported LNG is more realistically seen as a long-run move furthering the resiliency and global integration of natural gas markets. Alan Greenspan recommended a similar course of action in his testimony two weeks ago in Congress on natural gas prices.

Regulatory obstacles that constrain supply, including limitations on LNG terminal construction, drilling on federal lands, and offshore drilling, should be evaluated and put to a benefit-cost test. This test would ensure that the combined environmental benefits of the regulations and the fuel supply benefits outweigh the costs, including the opportunity costs of the foregone environmental and fuel supply benefits.

On the natural gas demand side, we should rethink our approach to air quality regulation. Too much air quality regulation mandates inputs, such as the use of natural gas, or a particular coal emission scrubbing technology. We would all benefit from an air quality regulatory framework that stipulates air quality objectives and enforcement technologies that regulators will employ. Setting outcome-based air quality performance standards and a transparent means of evaluating and enforcing performance is vastly superior to input-based regulations because it will provide polluters with the flexibility to improve and innovate better ways of meeting the performance standard. This innovation will reduce costs, and will produce new technologies. New knowledge could enhance our ability to achieve higher air quality and make available different fuels at prices we are willing to pay.

One final piece of the constructive action that governments can take to make energy markets more resilient is to free state-level electricity regulations to allow retail competition and demand-side bidding in retail markets. Not only will an active demand in retail electricity markets discipline the ability of suppliers to raise prices, it will also equip consumers with their most effective energy conservation tool. Demand response, particularly in large industrial and commercial customers, can send signals to power producers of how much investment in generation they should undertake. Conservation and shifting of demand away from costly peak hours can actually decrease the amount of required investment in generation capacity, as well as reducing overall fuel use.

Price increases transmit valuable information to consumers that enables them to decide when it is worth it to them to conserve. Price increases serve as the most effective inducement to conservation, because they signal to consumers large and small that the relative value of natural gas has increased. They also tell suppliers when it is worth bringing more to market and when to invest in more capacity, and through this interaction across time and place, fuel portfolios become more certain and prices become more stable. Government removal of obstacles to this vital transmission of information through market processes is the most productive and constructive action that governments can take in the face of this impending "natural gas crisis".

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.

Reducing California's Petroleum Dependence

info@reason.org (Joel Schwartz) info@reason.org (Lynne Kiesling) — Tue, 10 Jun 2003 00:00:00 EDT

A. Introduction and Summary

The CEC/CARB AB 2076 Report (hereafter "the Report") recommends that California set goals of reducing petroleum consumption to 15% below the 2000 level by 2020, and increasing the market share of alternative fuels to 15% of demand by 2020. The Report recommends achieving these goals by mandating a doubling of average automobile fuel economy and requiring that a minimum percentage of on-road transportation fuel be derived from non-petroleum sources.

The Report asserts that reducing petroleum use is necessary to mitigate the following problems:

High and volatile gasoline prices
High security costs for protecting middle east oil supplies
Inability to refine enough petroleum in California to meet California's demand
Mitigating environmental problems such as climate change and air pollution

The Report's cost benefit analysis concludes that mandating substantial increases in vehicle fuel economy would result in billions to tens of billions of dollars in net benefits to California's citizens over the next 30 years. On the other hand, the Report concludes that mandating alternative fuel use would result in billions of dollars in net costs to California's citizens.

We have grave concerns over the Report's assumptions about the nature of the problems, what problems are in need of policy solutions, the assumptions of the cost-benefit analyses, and the recommended solutions themselves. We summarize our concerns below and discuss them in greater detail in the rest of this comment letter.

Mandating fuel efficiency improvements will impose net costs on motorists. About 70% of the benefits claimed for fuel efficiency improvements are direct benefits to motorists in the form of savings in gasoline costs. But motorists can already purchase any of a few dozen vehicle models that get more than 30 miles per gallon (mpg), and yet, on average, they choose vehicles that get a bit more than 20 miles per gallon. Motorists are aware of the level and volatility of gasoline prices and no doubt take this into account in their purchase decisions. This suggests that whatever costs and benefits the Report counts in its cost-benefit analysis, they have little to do with motorists' actual valuation of greater fuel economy vis-à-vis other automobile amenities. When automakers can offer high-mileage vehicles with a palatable combination of price and other desired amenities, motorists will choose them without any external prodding. This suggests that mandating fuel efficiency increases will impose net costs on Americans. Therefore, rather than benefiting Californians, implementing the Report's recommendations would likely make people worse off.

Reducing petroleum consumption would not reduce oil security costs. The level of U.S. expenditures to protect middle east oil supplies is a matter of debate in the research literature. But whatever the costs are, marginal reductions in petroleum use won't reduce these costs. The level of military effort that policymakers judge to be necessary to protect the oil supply and meet other U.S. geopolitical interests is likely to be independent of oil consumption over a wide range of oil consumption levels. A 15% reduction in California or even U.S. oil consumption would probably have no effect on such decisions. The estimated benefits due to decreased oil security costs should be removed from the Report's cost benefit analysis.

Implementing the Report's recommendations would worsen future air quality. Existing CARB LEV II requirements will eliminate more than 90% of current vehicle emissions during the next 20 years or so, leaving little marginal benefit to be had through additional measures. Yet by making new cars more expensive, implementing the Report's recommendations will slow the rate of new-car purchases, which would in turn slow progress on air pollution by slowing vehicle-fleet turnover.

Internalizing the environmental cost of CO₂ emissions would not change motorist behavior. The Report estimates the harm from CO₂ emissions to be $15/ton, which is equivalent to about 15 ¢/gallon. These costs could be internalized through a gasoline tax, but such a tax is probably too small to change motorists driving behavior or vehicle-purchase decisions. If internalizing the cost of CO₂ emissions wouldn't appreciably change motorists' behavior, then requiring CO₂ reductions is almost guaranteed to impose net costs on society.

The Report assumes a static petroleum market. The Report assumes no changes in the petroleum market between now and 2030. But the petroleum market is dynamic. New oil development in Russia, the Caspian Sea, and West Africa, along with ongoing reductions in oil exploration and recovery costs, are reducing OPEC's ability to control petroleum supplies. These trends will tend to reduce both the future cost and volatility of petroleum.

The Report ignores government-mandated balkanization of fuel markets as a source of gasoline-price volatility. Some and perhaps much of the volatility in gasoline prices is due to regulatory requirements on fuel composition that vary from place to place. Despite this factor being under the complete control of state and federal policymakers, the Report does not address reforming reformulated-fuel requirements as a means of reducing price volatility.

Importing gasoline from out-of-state refineries is not a problem. The Report notes that California doesn't have enough in-state refining capacity to meet its future fuel needs and dubs this a problem. This is no more a problem than the fact that Los Angeles is a net importer of food. Gasoline producers will efficiently respond to consumer demand if allowed to do so.

Governments have a poor record in picking technology winners. The Report implicitly assumes that government can pick technology and alternative fuel "winners." Political manipulation of funding choices, the need for decentralized experimentation to determine optimal approaches, the rapid evolution of technologies and processes, and the market discipline of prices and consumer preferences to drive determinations of what's worth doing, all ensure that even the best intentioned central planners will do a poor job of picking the "right" approaches. The approaches that will bring net benefits to Californians are unknown and are most likely to be realized through a decentralized, market-based discovery process.

The Report recommends mandating alternative fuels even though its own analysis indicates this would impose billions in net costs. If after considering all costs and benefits of a policy one finds a net cost, then, by definition, implementing the policy will make people worse off. Rather than make California's economy more resilient, implementing the Report's recommendation would make the state's economy more brittle by requiring consumers and businesses to adopt an energy portfolio that they would not choose on their own due to its great costs. The extra energy costs would draw resources away from other productive activities and investments, reducing the resilience of households and businesses.

Summary. Overall, the Report suffers from an errant definition of the problems that need to be solved, and claims benefits for its recommended policies that would not actually materialize. Indeed, implementing the Report's recommendations would cause net harm to California's citizens. The Report's problem definitions and cost-benefit analyses require major rethinking and revision before the Report can be considered as a sound basis for fashioning energy policy in California.

B. The Report's Cost-Benefit Analysis of Fuel-Efficiency Improvements Is Inconsistent with Motorists' Actual Assessments of Costs and Benefits

In the energy efficiency scenarios, the Report estimates that cumulative net benefits from 2002-2030 of tens billions would result from implementing the Report's recommendation for a mandated doubling of average vehicle fuel economy. But the Report's analysis doesn't appear to have real-world validity.

About 70% of the benefits claimed for reducing petroleum use come from direct savings to motorists, who would spend less to purchase fuel if their cars were more fuel efficient. But motorists already have the opportunity to purchase any of a few dozen models that get more than 30 miles per gallon (mpg), yet they choose not to do so. On average, motorists choose cars that get a little over 21 mpg. This "revealed preference" shows that, on balance, motorists value the additional amenities of low-mpg vehicles more than the extra cost of the gasoline they consume. Indeed, motorists have continued to purchase low-mpg vehicles even during the last few years of relatively high and volatile oil prices.

Motorists have told us through their purchasing decisions that, all things considered, low-mpg vehicles provide a better combination of price and amenities than high-mpg vehicles. This suggests that the Report's analysis of the net benefits of raising fuel-efficiency requirements makes false assumptions about what motorists most value, and that raising fuel efficiency requirements would actually result in net costs to California's citizens.

One might argue that technological advances will reduce the cost of improved fuel economy in the future, which will improve the cost-benefit picture. We agree that this is very likely. But that is still not an argument to require improved fuel economy. Motorists will buy high-mpg vehicles without any prompting as soon as automakers can deliver high fuel efficiency in combination with the other amenities that most motorists desire and at a palatable cost.

Indeed, the argument for mandating greater fuel efficiency rests on a logical fallacy. The call for a government mandate is predicated on the assumption that automakers are purposely withholding fuel-efficient technologies that consumers would buy if they were offered. Yet such a claim implicitly assumes that profit-seeking automakers are foolishly refusing to offer products that would help them sell more vehicles and thereby gain market share. To avoid a logical contradiction, we would have to assume that regulators and environmental activists know more about how to please motorists and make auto companies more profitable than the managers, board members, and shareholders of those companies—a highly dubious proposition.

Another argument for requiring greater fuel efficiency is based on the external costs of automobile use that are not included in the purchase price of the vehicle or the cost of gasoline. But to the extent these costs are real, the appropriate way to deal with them is by adding them to the price of fuel and/or vehicles. But this approach would probably do little to increase demand for more fuel efficient vehicles, because the marginal increase in the cost of driving would be small.

For example, using CEC's estimate of $15/ton for the environmental costs imposed by CO₂ emissions, internalizing this cost would add 15 ¢/gallon to the cost of gasoline. Adding in the Report's assumption of 12 ¢/gallon for oil security costs would bring the total tax to 27 ¢/gallon. Assuming an average vehicle life of 120,000 miles, doubling average vehicle fuel economy from about 21 mpg to about 42 mpg would amount to an incremental savings in lifetime vehicle costs of only about $700, or about $60 per year. While this isn't a trivial amount of money, it is probably too small to have much effect on vehicle purchasing decisions or driving behavior. This analysis amplifies the concern about whether mandated fuel economy increases confer net benefits. If internalizing external costs of fuel use wouldn't cause much of a change in motorist behavior, then the Report must be wrong in concluding that mandating large increases in fuel economy would confer net benefits.

Frequent, painful experience keeps motorists acutely aware of both the price and price volatility of gasoline. The average motorist's refusal to purchase high-mpg vehicles is not due to lack of knowledge of benefits. Rather, on balance, the claimed benefits of high-mpg vehicles simply don't exist yet. Motorists find low-mpg vehicles to be a better overall value. When the price-amenity equation changes, as it surely will, motorists will choose high-mpg vehicles of their own free will and the result will be net societal benefits. Mandating higher fuel efficiency would only make motorists worse off.

C. Fuel Regulations Balkanize Markets and Increase Price Volatility

Some and perhaps much of the volatility in gasoline prices is due to regulatory requirements on fuel composition that vary from place to place. In particular, California's reformulated gasoline limits flexibility in the gasoline market by making non-California gasoline less substitutable for California's reformulated gasoline. Likewise, the federal government requires the addition of oxygenates, a requirement which can now practically be met only with ethanol. This balkanization of fuel markets enables price spikes to occur and to persist. Despite these factors being under the complete control of state and federal policymakers, the Report does not address reforming reformulated-fuel requirements as a means of reducing price volatility.

CEC and CARB should commission an independent analysis of the effect of fuel regulations on gasoline-price volatility, and examine opportunities for more flexible regulations that would maintain air quality benefits while reducing the potential for supply disruptions and ensuing price spikes.

D. World Petroleum Markets Are Dynamic, but the Report Assumes A Static Market

The Report is founded on a static view of petroleum markets, one that assumes little or no change in the global oil industry over the decades covered in the analysis. In particular, likely changes in world oil markets over the next 20 years are assumed away. For example, the report ignores the development and capital investment in Russia, around the Caspian Sea, and in West Africa, as well as continually declining costs for oil exploration and recovery. As a result, almost all of the growth in oil production is occurring in non-OPEC countries. This growth reduces OPEC's market power, and threatens to reduce its market share, reducing its ability to control supply and prices.

Another important dynamic aspect of energy markets is the use of financial instruments and contracts to reduce risk and, consequently, to reduce price volatility beyond what it otherwise would have been. The report never addresses the role that financial markets (hedging, derivatives, etc.) play in reducing fuel price volatility, without the need for additional government action, regulation, or planning.

At the very least the Report should incorporate scenario analyses based on different world oil market contexts, as a test of how robust its conclusions are to the dynamics of the ever-changing global oil market.

E. Governments Have A Poor Record in Trying to Pick Technology "Winners"

In discussing the move away from petroleum-based fuels to fuel cells, the Report implicitly assumes that the government policymakers can pick technology winners, and that it can control both the rate and outcome of technology and process innovation. Governments (and corporate bureaucracies, for that matter) have a very poor track record of picking technology winners, and we have little reason to believe that the success rate in this case will be any different.

The most dramatic example of government subsidies to unsuccessful commercialization research is federal subsidies to solar thermal research during the late 1970s. In the wake of the energy crisis of the 1970s, Congress and the Carter Administration approved a large budget increase for research into thermal solar technology. Five years and massive amounts of research did not yield a commercially viable competing technology to the old photovoltaic solar cells, the technology of which had of course also advanced.

In the case of hydrogen generation, storage, and transport, fuel cells, fueling infrastructure, and so on, there are several competing technologies all innovating simultaneously. We do not know which one in each area is the most commercializable, and even if we could somehow generate a sound current ranking, a sudden discovery in one technology could upend that ranking in an instant. Technological developments in other areas could even reduce interest in fuel cells. Government-guided research runs the risk of choosing the wrong technologies.

If the government attempts to pick winners through targeted subsidies and picks wrong, then we are stuck with that bad, costly mistake. This mistake could become particularly costly once, for example, companies start building, hydrogen fueling stations, investing in a lot of fixed infrastructure in special purpose assets if it turns out that the most commercially viable way to deliver the hydrogen is not compatible with those specific assets. Such a costly policy error would lead to significant wasted investment, and if subsidized, a lot of wasted taxpayer money.

Private markets are a superior way to make decisions about technologies and funding levels. Investors use market processes to deal with such unknowns by holding diversified portfolios of venture capital. Venture capital firms do not typically sink all of their resources into one technology that they believe has the highest probability of winning – they hedge that investment by investing in other technologies, in other industries. They want to maximize their risk-adjusted profit, knowing full well that some research will result in new technologies that deliver new and/or improved benefits at lower costs to consumers, and some will not. Such a portfolio approach is a hedge against the pervasive inability to pick winners. Experience with government research suggests that its track record does not improve upon the private investment portfolio approach.

One of the arguments in favor of targeted government technology research subsidies is that such subsidies will reduce unnecessary duplication of research efforts. If there is duplication of research, that means that there is plenty of private-sector interest in the topic, so increasing government subsidies will only serve to crowd out that private investment in research that would have happened anyway. Why spend taxpayer money that way when private investors are willing to incur research costs?

One typical answer to that question is that duplicative research efforts are a wasteful dissipation of resources in the race to be "first to the finish line." That argument ignores the benefits of duplicative research. If you try to channel these efforts and guide research with an objective of minimizing duplication, you are very likely to fail, because the duplication is never perfect—even if several people are working toward the same goal, such as smaller or cheaper fuel cells, the variations in their procedures, materials, ways of approaching the problem, and just sheer luck will all lead them down different paths. This decentralized discovery process maximizes the potential benefits from research. All of that seeming duplication is not duplication at all. Instead, it maximizes the probability that someone will come up with technologies and processes of greater benefit to society. And the fact that the search is decentralized and diverse means that society doesn't have all its eggs in one basket.

Government research subsidies and those who argue for them also tend to overlook a very important part of the technology diffusion process: consumer demand. Technologies that do not meet consumer needs for practicality, convenience, carrying capacity, power, and aesthetics will fail, regardless of their scientific virtuosity or cost-effectiveness. Failure to take into account consumer demand further inhibits the ability of government to pick winners, and also points up another major difference between private investment processes and government subsidy processes.

The Report ignores the preferences of consumers, which is how it was able to manufacture benefits from mandated fuel-efficiency requirements. The costs used in the cost-benefit analysis do not include the changes to vehicles that would have to occur to make the increased fuel efficiency happen: decreased power, decreased torque, decreased size, and possibly decreased safety. These features matter to consumers, and government dictation of the features that peoples' vehicles will have would likely make consumers worse off.

It is important to remember that technological change is incremental and evolutionary, and that important features, processes and technologies can be very different from what one might have expected at the beginning of a research program. Predicting what will succeed and what will be a dead end is difficult, so any policy decisions that steer research into bureaucratically determined paths could do more harm than good.

F. Mandating Alternative Fuels will Harm Californians

Despite finding that requiring alternative fuels would cause billions of dollars in net harm to Californians, the Report recommends a mandated minimum market share of 15% for alternative fuels. The Report's rationale is that it will make California's economy more resilient. But this is a non-sequitur. If after considering all costs and benefits of a policy one finds a net cost, then, by definition, implementing the policy will make people worse off overall. Indeed, the Report's recommendation for an alternative fuels mandate is in effect an argument that we should shoot ourselves in the foot now in order to avoid the risk that we might get shot in the foot later.

Rather than make California's economy more resilient, implementing the Report's recommendation would make the state's economy more brittle by requiring consumers and businesses to adopt an energy portfolio that no one would choose on their own due to its great cost and risk. The extra energy costs would draw resources away from other productive activities and investments, reducing the resilience of households and businesses. The recommendation for an alternative fuels mandate should be removed from the report.

G. Environmental Problems

The Report identifies two major environmental problems—air pollution and global warming, which we take up in turn.

1. Air Pollution

Increasing petroleum use is not an obstacle to improved air quality

The Report states "Increasing our reliance on petroleum would…be an obstacle to improved air quality." This statement is simply false. According to the Report, gasoline consumption rose 50% in California between 1980 and 2002, yet this was a period of extraordinary improvement in California's air quality. During the 1980s, the San Bernardino area, with the worst ozone levels in the nation, exceeded the federal 1-hour ozone standard about 140 times per year. Today, Crestline—the worst location—is down to about 25 exceedances per year, while San Bernardino and Redlands average around 10 to 20. Half the population of South Coast now lives in areas that meet both the 1-hour and 8-hour ozone standards, while about 99 percent of people in the Bay Area and San Diego likewise live in areas meeting both ozone standards. Figure 1 displays the trend in 1-hour ozone exceedances at the worst monitoring location in each of California's major air basins.

Levels of all other pollutants have likewise declined substantially during the last 20 to 30 years. The vast majority of monitoring locations now comply with federal PM10 standards, and the entire state complies with standards for CO, NOx and sulfur dioxide.

Figure 1. Trend in 1-hour Ozone Exceedances at Worst Location in Each Air Basin

Source: CARB monitoring data

These declines will continue, regardless of VMT growth. Tunnel studies show that fleet-average light-duty-vehicle HC emissions in California are declining about 15% per year, while NOx is declining about 9% per year (see Figure 2). Given that VMT is increasing about 1.8% per year, this results in a net annual decline HC and NOx of 13% and 7% respectively. These trends will only continue. A fleet meeting CARB's LEV II requirements for gasoline vehicles would emit more than 90% less HC and NOx per mile of travel than the fleet currently on the road. The fleet will turn over to these vehicles during the next 20 years or so. VMT increases will have little effect on future emissions, given these large per-mile emission reductions. For example, if per-mile emissions decline 90% and VMT increases 50%, total emissions would still decline by 85%.

Thus, the long run problem of air pollution from automobiles has already been solved by existing requirements that will come to fruition during the next 20 years or so. But we still have a near-term air pollution problem. This problem would be most quickly and cheaply resolved through repair or scrappage of high-emitting vehicles. A small percentage of vehicles contributes most fleet emissions (see Figure 3). For example, remote sensing data collected in Riverside, California in 2001 show that the worst 5% of HC emitters account for more than 50% of tailpipe HC emissions. As the chart shows, the vast majority of vehicles have very low emissions, while a few have very high emissions and account for most pollution from the fleet.

This means that most vehicle emissions are not due to petroleum consumption per se, but to the small percentage of vehicles with broken emission control systems. To solve this problem, we should focus on measures to identify and either repair or scrap these high emitters. This is also only a near-term problem, as these older high emitters are slowly but surely being replaced by more recent models that stay cleaner throughout their lives.

Figure 2. Trend in Fleet-Average Emissions of California Light-Duty Vehicles, 1994-2001

Source: A. J. Kean et al., "Trends in Exhaust Emissions from In-Use California Light-Duty Vehicles, 1994-2001," (Society of Automotive Engineers, 2002).

Figure 3. VOC Emissions Distribution of Vehicles Measured by Remote Sensing in Riverside, California in 2001

HC emissions from 1,207 vehicles with 2 or more measurements, ranked from cleanest to dirtiest. Emissions are in grams of VOC emitted per gallon of fuel burned. Negative HC readings represent "real" noise in the data. Data were collected in Riverside, California in 2001 by Gary Bishop of the University of Denver. Data were downloaded from www.feat.biochem.du.edu/light_duty_vehicles.html. These vehicles are 15 years old on average, and 75 percent are at least 12 years old.

Air Pollution Reductions Beyond Current Requirements would Result in Little or No Marginal Benefit. Because current air pollution problems are being solved by existing measures, there is little or no marginal benefit to additional pollution reductions over and above those that will occur due to existing LEV II and other vehicle emission requirements. The Report implicitly acknowledges this, as its estimated air quality benefits from reduced petroleum consumption amount to about 50 cents per person per year, or one percent of all estimated benefits. These presumed benefits are also due to pollution reductions from a baseline pollution level that is already below the limits set by federal and California health standards.

Implementing the Report's Recommendations would Make Future Air Quality Worse than it Would Otherwise Be. Implementing the Report's recommendations would make new cars more expensive. As a result, people would buy fewer new cars and would hold on to existing cars longer. Since fleet turnover is the most important factor for air quality improvements, implementing the Report's recommendations would make future air quality worse than it would otherwise be. Rather than counting air pollution benefits in its cost-benefit analysis, the Report should actually conclude that implementing its recommendations would impose air quality costs.

The Report Overestimates the Health Improvements from Air Pollution Reductions. Even the small amount of health benefits attributed to additional air pollution reductions are overstated. Most of the claimed benefits are due to projected reductions in mortality due to reductions in particulate matter (PM). The Report bases its PM mortality estimate on the Health Effects Institute's (HEI) Reanalysis of the American Cancer Society (ACS) study of PM and mortality. However, residual confounding in this study makes it likely that the results are spurious. For example, the HEI/ACS study reported that PM increased mortality for men, but not women; for those with no more than a high school degree, but not those with at least some college education; for those who said they were moderately active, but not those who said they were either sedentary or very active; and for former smokers, but not current or never smokers. These results are biologically implausible and suggest that residual confounding accounts for them. The report also found no increase in mortality due to respiratory causes specifically, which is surprising given that air pollution would be expected to exert its effects through the respiratory system.

At the very least, taking the HEI/ACS results at face value, only the 25% of the population that is male and has no more than a high school degree would be expected to suffer increased mortality. The Report also ignores the results of a recent epidemiologic cohort study of veterans with high blood pressure that found no relationship between PM levels and mortality, despite that this group was expected to be particularly susceptible to air pollution's effects. These results indicate that the Report's benefit estimates for air pollution reductions are greatly overstated.

Summary. Air quality in 10 or 20 years will be far better than it is today, regardless of California's policy on petroleum consumption. Furthermore, virtually none of the purported benefits of reduced petroleum consumption are due to air quality improvements. Thus, it is at best terribly misleading for the Report to either raise alarms about future air quality, or to suggest that reduced petroleum consumption is a sensible policy for air quality improvement, when other policies would provide greater and more rapid pollution reductions and would do so without the harm that would be caused by mandated fuel efficiency improvements or mandated alternative fuel usage.

Instead, the Report should state prominently that (1) air quality is improving and will continue to improve regardless of California's petroleum consumption trends, (2) mandating higher fuel economy would slow fleet turnover by making new vehicles more expensive, thereby making future air quality worse than it would otherwise be, (3) existing requirements will eliminate almost all remaining automobile air pollution during the next 20 years or so, and (4) near-term air pollution improvement would be most quickly and cheaply achieved through repair or scrappage of high-emitting vehicles.

2. Climate change

Climate change is an analytically complex issue, and forecasts of future climate change and attendant costs are fraught with uncertainties. A detailed discussion is beyond the scope of these comments. However, even taking the Report's damage estimates from CO₂ emissions at face value, eliminating the CO₂ emissions would cost more than the estimated harm caused by the emissions. This alone guarantees that CO₂ reductions will cause net harm. A simple analysis shows why this is the case.

The Report estimates the harm from CO₂ emissions to be $15/ton, which is equivalent to about 15 ¢/gallon. These costs could be internalized through a gasoline tax, but such a tax is probably too small to change motorists driving behavior or vehicle-purchase decisions. For example, buying a 42 mpg vehicle instead of a 21 mpg vehicle would save only about $35 per year in CO₂ taxes. This means that even charging motorists the full estimated cost of all of their CO₂ emissions would likely cause hardly any reduction in CO₂ emissions. If internalizing the cost of CO₂ emissions wouldn't appreciably change motorists' behavior, then requiring CO₂ reductions is almost guaranteed to impose net costs on society.

The Report also notes "Our estimate of $15 per ton of CO₂ equivalent seems reasonable if cost of control or current market trades are any indication. $15/ton is also consistent with the finding of Friedrich and Bickel that damage estimates currently are lower than cost of control or market trades." If the damage done by a ton of CO₂ emissions is less than the cost of reducing those emissions, then reducing the emissions will cause net harm.

H. Oil Supply Risk: Marginal Reductions in Petroleum Consumption will Not Reduce Military or other Expenditures to Protect Foreign Oil Supplies

The Report includes benefits from reduced oil security costs as part of the estimated benefits of reduced petroleum consumption. As the Report notes, there is little agreement in the research literature over just what those costs are. However, whatever the costs are, the reduction in oil security costs due to marginal reductions in petroleum consumption is likely to be zero. This is because the nature and extent of U.S. military activity to protect U.S. interests in the middle east are not elastic with oil consumption. Instead, such missions depend on a range of interacting geopolitical factors of which oil is only one.

Furthermore, the level of military effort judged to be necessary is likely to be independent of oil consumption over a wide range of oil consumption levels. After all, regardless of whether the U.S. imports 20% or 30% of its oil from the middle east, the military effort necessary to ensure its availability would likely be the same. Even if the U.S. imported hardly any of its oil from the middle east, the U.S. might consider it strategically important to protect middle east oil anyway, since many of its allies would import much their oil from the middle east.

The Report bases its estimates of oil security costs on two reports—Delucchi and Murphy (1996), and Lieby et al. (1997). But Delucchi and Murphy base their estimates on the assumption that all middle east oil consumption is ended, rather than on marginal reductions. And Leiby et al. state outright that oil security costs do not necessarily vary with marginal changes in imports. Thus, the research literature cited in the Report actually doesn't support the Report's assumption that the U.S. could achieve marginal reductions in oil security cost through marginal reductions in petroleum consumption.

Ironically, reducing petroleum demand is instead likely to increase the percentage of oil imports that come from the middle east. Middle eastern countries are generally the lowest-cost suppliers, so reductions in demand would push other suppliers out of the market, increasing the middle east's market share.

Improvements in oil security account for roughly 10 to 15 percent of the Report's estimated benefits from reducing petroleum dependence. Since these benefits would not actually materialize, they should be removed from the Report's benefits ledger.

Joel Schwartz is an adjunct fellow at Reason Foundation and visiting scholar at American Enterprise Institute.

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.

Oil and Gas Price Stability

info@reason.org (Lynne Kiesling) — Tue, 27 Aug 2002 00:00:00 EDT

Even with the threat of military action in the Persian Gulf and the upcoming Labor Day holiday weekend, both crude oil and gasoline prices are pretty darn stable (although oil prices, especially, are high; more on that in a second). On gasoline, this Reuters article summarizes the results of the regular Lundberg survey of gasoline stations. In the most recent survey, gasoline prices were very stable, at levels sustained over 20 weeks! How often does that happen in the summer? Not very! This price stability is at least in part a result of the production substitution of gasoline for other distillate products such as diesel and jet fuel, which are less in demand because of economic slowness and the fact that many of us won't set foot on a plane unless we absolutely have to. So enough supply has been out there to meet demand without price having to adjust abruptly. Isn't economics beautiful?

Now, I'm sure you're thinking that I overstate the price stability of crude oil. Perhaps, but prices are not fluctuating as much as you might expect given that we are going into the fall/winter heating season and are talking about what to do in Iraq. According to this Bloomberg Energy article from Monday, oil prices have risen 49 percent during 2002, but they have been stable over the past month. This stability is at least in part due to changes in expectations — even though talk of taking on Iraq continues, oil market participants have become less convinced that such action would lead to oil supply disruptions. Those changed expectations have brought some stability to oil markets.

Stable, yes, but at a pretty high price, toying with $30 a barrel. Today Forbes reported that oil prices are rising today, toying again with $30 a barrel. What's so magical about $30? Once prices go above $30, OPEC begins to consider raising its output, as the two articles linked above point out. OPEC continues to struggle with balancing the incentive to reduce output to raise prices with calls from some member states, such as Nigeria, to raise their quotas so they can raise some money. Combine these dueling incentives with the slow economic growth that we are currently experiencing, and you have OPEC caught between Scylla and Charybdis. That's why Bloomberg Energy reports today that OPEC will probably discuss increasing production next month. Fascinating.

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.

Consumers, Gas Prices Better Off Without Help From Politicians

info@reason.org (Lynne Kiesling) — Tue, 14 May 2002 00:00:00 EDT

Knight-Ridder Tribune Wire

Memorial Day and summer usually bring higher gas prices. And it is becoming increasingly clear that most politicians don't have a clue about what causes gas prices to rise.

A 10-month, 396 page Senate subcommittee report desperately searching for a price gouging conspiracy among big oil companies didn't find one. With nothing illegal going on, the report was left to complain that there aren't enough oil companies competing in the market.

At the same time the Senate was releasing its report, the Hawaii legislature was voting to impose price caps on gasoline starting in 2004. The old saying is that those who don't learn from history are doomed to repeat it. The gas lines in Hawaii, and in any other states foolish enough to institute price controls, will resemble the long lines of the 1970s because price caps will likely cause supply shortages instead of low prices.

The irony in all this government activity is that letting the market dictate gas prices, even if that means higher prices, would help us achieve many of our long-term energy and environmental goals — conservation, reduced dependence on foreign oil and reduced emissions through the use of alternative fuels.

Whether it is buying a car or buying groceries, we all make budgetary decisions everyday. And as crazy as it seems to politicians, consumers will adjust to any increase or decrease in gas prices. Faced with high gas prices, we might choose to drive less, combine trips, carpool, or choose more fuel-efficient vehicles — but somehow, someway, we will adjust our lifestyles accordingly.

Following the OPEC embargo and price caps of the 1970s, Americans embraced a new breed of fuel-efficient vehicles. Sales of Volkswagens, Hondas, Nissans and Toyota's soared as consumers decided they could save time and money by driving more fuel efficient cars.

American automakers also learned a lesson when consumers turned to those fuel-efficient cars, almost all of which happened to be foreign made. Today, even as SUV sales soar, U.S. carmakers are preparing for changing consumer wants and needs by ramping up development of hybrid cars that get excellent gas mileage and produce much lower emissions. Ford is producing a hybrid version of its Escape SUV. Dodge and General Motors have plans for hybrid, full-size pickup trucks.

It seems everyone is embracing the principles of capitalism, except politicians. Election year grandstanding is partially to blame for the rhetoric and misguided actions, like Hawaii's price caps. Just as the seasons change, every couple of years, wannabe superhero politicians launch investigations to save poor unwitting consumers from Big Oil's plot to take our money.

Big Oil only wishes it were so simple. After all, most oil companies are not turning huge profits these days — ChevronTexaco's first quarter net income was down 70 percent. Contrary to the Senate�s assertions, oil companies are in fact fiercely fighting each other for our money. Additionally, regulations, that vary from state to state, force oil companies to jump through numerous costly hoops before getting gas to the pumps.

Many areas across the country, especially California, New York and the Midwest, use special boutique, clean-burning fuels designed to meet various Clean Air standards set by the Environmental Protection Agency and the states themselves. Unfortunately, different regions of the country have set different standards and thus require different fuels. So, if a refinery that produces gas for Chicago or St. Louis has a problem or accident, oil companies can't simply turn to a refinery in California to make up the shortage because the gas being produced there is completely different.

In addition to the boutique fuels, we pay lots and lots of taxes at the gas station. The federal government adds 18.4 cents a gallon in taxes, and then states tag their own taxes on top of that. For example in addition to the federal taxes, California, Connecticut, Hawaii and New York all charge over 30 cents per gallon in taxes. Obviously, oil companies aren't the only ones profiting from the sale of gasoline.

Politicians should stop trying to control natural fluctuations in the petroleum market. They can't prevent problems at refineries and they definitely can't control what goes on in the Middle East. The government's best course of action is to step away from the gas pumps and let the market run its course. Politicians will be pleasantly surprised at how savvy consumers are and how proficient free markets are.

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.

Feds Should Let Gas Prices Run Their Course

sam.staley@reason.org (Samuel Staley) info@reason.org (Lynne Kiesling) — Wed, 08 May 2002 00:00:00 EDT

On Monday U.S. Senate Democrats released a study concluding that Big Oil is doing what most Americans suspected anyway — using their market power to raise prices above competitive levels. Oddly enough, this may be good news for the American economy. Big Oil's use of its market power may generate larger, more broad-based social benefits than critics might realize. As Joseph Schumpeter is famous for pointing out, industry profits encourage innovations that reduce that profit, but create profit for entrepreneurs.

Of course, whether the major oil companies are conspiring to keep gas prices high is at least debatable. After all, as the study points out, the causes of gas price fluctuations are complex, ranging from crude oil prices to refining capacity, seasonal demand, and air pollution regulation. The Senate study focused on domestic refining, not incorporating the effects of increased crude oil prices in 2000 and early 2001. Refining profit margins increased in 2000 and the first half of 2001, before crashing post-September 11.

Nevertheless, the Senate study's conclusions raise a more important question: So what? Are higher gas prices really a bad thing? Many analysts, including environmentalists, argue that one of the fundamental problems with America's transportation market is that driving (and gasoline) is too cheap. Oil is a fossil fuel, and its supplies are finite (although analysts really don't know precisely how large global reserves are). Conservation, then, should be a laudable goal of public policy. Prices are an important tool for promoting conservation.

Environmentalists argue further that the "boutique fuels" that the Environmental Protection Agency implemented in 1995 internalize some of the environmental costs of gasoline consumption. However, the array of boutique fuels in different metropolitan areas, especially in the Midwest, fragments markets and makes both demand and supply less responsive to price changes. Diminished price responsiveness leads to higher and more volatile prices. And as we have seen in earning declarations in the past month, profits are more volatile too, as oil companies bear the cost of the market risk associated with recession in their lower refining margins.

Price responsiveness is one of the key components in achieving economic efficiency. After all, one of the primary purposes of a product's price is to give consumers and producers information about how scarce goods and services are. Higher gas prices provide a strong signal to consumers that gasoline is becoming more scarce, or that the cost of making it has increased. The higher the price, the less consumers will use.

Higher prices will have at least two effects in the transportation market, both of which have substantial potential long-term payoffs. In the short run, consumers will use less gas: We will combine trips to cut down on the gas used to start and run our cars; we will use the smaller, more fuel-efficient car rather than the gas guzzling van or SUV; more people will opt for telecommuting. We might even shorten our trips, or begin to carpool. Gasoline demand is not very responsive to price changes, but some decrease in demand would occur nonetheless.

In the longer run, higher gas prices will transform the automobile industry, just as they did three decades ago. Many baby boomers may nostalgically remember their first VW bug or van in the 1960s, but foreign cars really gained their foothold in the American car market when gas prices skyrocketed in the 1970s in the wake of OPEC and domestic oil price controls that persisted until 1981. Volkswagen and Nissan benefited early, but soon Toyota and Honda rounded out the market in the early years of this price-and-regulation-induced transformation.

Now, unlike earlier decades, American automakers are poised to reap the advantages of a more conservation minded auto-buying public. Those unprofitable small car lines will become economically viable as gas prices increase. In addition, higher gas prices will fuel consumer demand for hybrid cars, which boast 60 or more miles to the gallon, as well as encouraging investment in research into new technologies that reduce or eliminate the use of gasoline.

Of course, if these changes occur — and we have lots of experience in the market to indicate they will — history will show that Big Oil will get its comeuppance through the discipline of the market. As people switch to more fuel-efficient cars or change their driving habits, and technological change reduces our use of fossil fuels, profit margins in the oil industry will be squeezed even more and the overall demand for gasoline (and oil) will fall. What look like monopoly profits now may disappear if the industry does not innovate to deliver better alternatives to customers.

Of course, even if we believe that lower gas prices are better overall, the notion that the federal government can jump in effectively to address this "problem" is remote. As the tone of the Senate study suggested, intervention is likely to target keeping gasoline prices down — a move that might reap short-term gains with voters but is likely to discourage socially beneficial and efficient changes in the market.

Oddly enough, the Senate report on gasoline prices makes a stronger case for letting the market run its course than federal intervention to try to make things "right." For the sake of argument, assume the cost increase from the EPA "boutique fuel" policies does internalize environmental costs and gets passed on to consumers. Higher gasoline prices signal to consumers and innovators that they should pursue other alternatives. Artificially reducing gasoline prices will succeed in prolonging our dependence on fossil fuels beyond what makes economic sense. Instead, let the oil industry fly or fall in the perennial gale of creative destruction — consumers, innovative entrepreneurs and the environment will be the ones who benefit.

Samuel Staley is director of urban and land use policy at Reason Foundation and co-editor of the book "Smarter Growth: Market-Based Strategies for Land-Use Planning in the 21st Century."

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.

Oil Markets and the 21st Century War

info@reason.org (Lynne Kiesling) — Wed, 26 Sep 2001 00:00:00 EDT

When four hijacked commercial airliner crashed into the World Trade Center, the Pentagon, and a remote field in Pennsylvania on September 11, shockwaves rapidly spread across the world economy. Not immune to these ripple effects, energy prices were also affected. Fortunately, a financial mechanism that helps stabilize commodity prices limited the effects of the attacks—a true lesson in the way markets cope with unexpected shocks and how we all benefit from such market instruments.

The day of the attacks, oil and gasoline prices initially spiked. Reports indicated that some stations increased gasoline prices to $4.00 a gallon. Many people feared disruption of the oil supply from the Middle East, especially if the U.S. pursued a military response similar to the Gulf War in 1991. Recalling the high oil and gas prices associated with that campaign, energy market participants expected that supplies would tighten and prices would go up. Even consumers, rushing to fill their tanks, magnified these short-term effects. Oil futures prices also went up initially, because these expectations and the response of the public created an incentive for energy firms to lock in supplies for the future, in anticipation of supply constraints.

Yet, two weeks later, oil prices and oil futures prices are the lowest they've been since 1991, and last week gasoline prices dropped 4.4 cents on average. Why? The answer to that question illustrates the complex interaction of supply and demand, time, and politics.

Oil and gas futures prices tell us a lot about what people in the industry think prospects are for higher prices in these uncertain times. After September 17 oil futures prices started to fall, and Monday, September 24 saw a 15 percent decrease in oil futures prices.

Prices for commodities like oil and gasoline are based on expectations of future supply and demand, and these prices move in response to unexpected events. Soon after the attacks, market observers thought that the future demand for oil and gasoline would more likely increase, because of possible military action. As it became more apparent that any military response would not be traditional or petroleum-intensive, these expectations changed. Traders also faced probable decreases in the demand for jet fuel because of reduced travel, as well as increased expectations of actual recession, perhaps even global recession. Even before September 11 consumer spending was in decline, which would lead to decreased production. Because petroleum products are fundamental to so many industrial and commercial processes, a recession could decrease demand. On top of that, long-term weather forecasts suggest fewer cold days than average in the next three months, lessening the expected demand for home heating. These expectations of lower demand drove current and future oil prices down.

What about supply effects? OPEC is known as an oil cartel that tries to manage the production in its member states, targeting prices in the $22-28 per barrel range. If they cut production to raise prices, that move could counter the expectations of falling demand and possibly lead to higher oil prices. OPEC, though, is under serious political pressure to support the U.S. in its efforts against terrorism, and a cut in oil production would not be seen as supportive. Most analysts believe that OPEC member states could lose a lot politically in return for a small gain if they curtailed production. In particular, Saudi Arabia, OPEC's largest member state, has pledged to support the U.S. At its planned meeting on September 26, OPEC announced that it would not change production plans, thus meeting traders' expectations for future supply. In addition to OPEC's effects, the recent high oil, gasoline and natural gas prices in the U.S. have led suppliers to increase their inventories, particularly of products with high winter demand such as home heating oil. Expected lower demand and stable supplies also contributed to falling oil futures prices.

Behind all these machinations lies the usefulness of futures markets at reducing price volatility, even in the wake of such a catastrophic event. They help buyers and sellers manage risk in potentially volatile markets, like oil and gas, by creating the ability to buy and sell today the rights to a commodity in the future. Consumers (individual and business) benefit from these instruments, through stable energy prices and the resulting predictability and ability to plan their own energy budgets.

Buyers and sellers acting on their expectations convey a lot of information about market conditions. From the current futures prices, market participants expect an economic downturn to last into early 2002, but not much beyond that. Of course, if something unanticipated happens or some new information arises, those expectations will change and be reflected in changes in futures prices. But incorporating expectations of future prices into current production and consumption decisions reduces volatility and contributes to more stable and certain markets, for energy and for other goods and services.

No doubt, we owe a debt of gratitude to many different people and institutions in the wake of these attacks—the workers and volunteers that risk their lives to save others, the entrepreneurs that keep the wheels of the economy turning, the government response that is helping manage the crisis, and a financial mechanism that helped keep the economy from choking on sky-high energy prices.

Lynne Kiesling is director of economic policy at Reason Foundation and senior lecturer in economics at Northwestern University.