Energy Independence

One of the most numbing and continually irritating sound bytes that keeps coming up in this election cycle is “Energy Independence.” Both candidates are equally to blame.

Apparently, in the world these people live in, buying oil from Canada is dandy. Buying from Venezuela or Saudi Arabia is like peeing on the American flag. It’s almost as if they believe that Canadian oil is somehow a sweeter, prettier grade of crude that just feels better in our refineries.

Oil is a fungible commodity. That means that a barrel of light crude that’s pumped in Texas is exactly the same as a barrel of light crude that’s pumped in BabyKillingTerroristIstanAbad-Zuela. Exactly the same.

Oil is a commodity traded on international markets. That means the barrel of sweet, sweet Canadian light crude costs exactly the same amount as a barrel of disgustingly foul putrid light crude that comes from Iran. Even if we could buy all our oil from Canada, Mexico, and Care Bear Land, our purchasing would have the same effect on prices that it would have if we bought the oil from Satan himself.

This is a great analogy (courtesy of Reason)

S. Fred Singer [of the Science and Environmental Policy Project] came up with the best analogy. He described the global oil market like a big bathtub. All the oil production is dumped into one bathtub and all consumers have straws sucking oil out. [For all economic purposes] it’s like we’re all sucking from the same common pool. To say you are not gonna buy Saudi oil, or Algerian oil—it’s crazy. For example, the U.S. hasn’t purchased a dime of Iranian oil—except for a small amount in the early ‘90s, but for the most part no Iranian oil since 1979. And that hasn’t stopped Iran from supporting Hezbollah.

If we buy our oil from Canada, then China will buy oil from Iran. If we buy from Mexico, then Russia will buy from Venezuela. But more to the point, Oil is a commodity that is sold and resold. We don’t buy oil from the Canadian General Store or Fascists ‘R Us, we buy it from commodity brokers, who buy it from speculators, who buy it from brokers, who buy it in lots from all producers. Obama and McCain would have you believe that buying oil from Saudi Arabia is wrong and bad and evil, but buying oil from a Canadian broker that bought that oil from Saudi Arabia is just super keen. It’s absurd.

Finally, this is an issue where when Reason magazine (“The Impossible Dream of Energy Independence“) and Mother Jones (“The Seven Myths of energy Independence“) agree. That should say it all.

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Peak Oil

Basically, Peak Oil is the idea that someday (soon!) we’ll run out of oil. To quote from Wikipedia,

Peak oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline.” (soon!)

There are a lot of people tossing numbers and projections and figures and expectations (soon!, really soon!) about when we’ll hit Peak Oil. (the end is nigh!) In the current economic climate, we’ll undoubtedly hear a lot about Peak Oil and our dependence on fossil fuels. It’s important to remember that it’s all wrong.

Oil reserves are infinite. Yep, that’s right. They’re infinite.

The earth’s natural resources are finite, which means that if we use them continuously, we will eventually exhaust them. This basic observation is undeniable. But another way of looking at the issue is far more relevant to assessing people’s well-being. Our exhaustible and unreproducible natural resources, if measured in terms of their prospective contribution to human welfare, can actually increase year after year, perhaps never coming anywhere near exhaustion. How can this be? The answer lies in the fact that the effective stocks of natural resources are continually expanded by the same technological developments that have fueled the extraordinary growth in living standards since the industrial revolution. — The Concise Encyclopedia of Economics

That doesn’t mean that the price of oil won’t rise. Prices rise as a resource is consumed–that’s what stimulates innovation and competition, which is what increases the effective reserves. (It’s also important to note that oil is affected by a lot of political externalities that affect its current price. The war in Iraq and the artificial supply constraints practiced by OPEC are the most important.)

One camp (primarily geologists) argues that few, if any, major new oil fields remain to be found and that mathematical calculation demonstrates that production will peak at some point in the not-too-distant future and then begin a slow but steady decline. Another camp (primarily economists) contends that reserves are as much an economic as a geologic phenomenon. That is, reserves are discovered and counted when it makes economic sense to find them. Thus, we do not know how much economically profitable oil has yet to be “discovered.” Technological advances are adding reserves at a far greater rate than they are being depleted. For example, in 1970, non-OPEC countries had about 200 billion barrels in reserves. Through 2003, they had produced 460 billion barrels and still had 209 billion barrels remaining. Although the debate is inconclusive, the weight of the evidence suggests that economists have the better argument. — The Concise Encyclopedia of Economics

Resources aren’t just things, they’re things that get used and that’s important. If we’re trying to figure out how much of a resource we have, it’s important to look at how we use that resource. In that respect, it’s important to look at all the ways that use a resource and pay attention to whatever policy choices we make. Oil reserves may be effectively infinite, but that doesn’t mean that we shouldn’t pursue other forms of energy. Neither does it mean that we shouldn’t necessarily conserve our use of a resource, although it does mean that conservation efforts should be tailored to achieve some actual good other than mere conservation. Take CAFE, for example,

An example of the economic case against direct regulation is the fuel economy standards for cars and trucks. The Congressional Budget Office estimates that increasing the Corporate Average Fuel Efficiency (CAFE) standards to achieve a 10 percent reduction in gasoline consumption would cost producers and consumers about $3.6 billion a year more than the value of fuel savings, or about a net cost of $228 per new vehicle sold. Achieving the same reduction through a gasoline tax increase of 46 cents per gallon would cost producers and consumers about $2.9 billion a year, or $184 per new vehicle sold. While few dispute such observations, CAFE standards are more politically palatable than gasoline taxes because the costs of the former are hidden from consumers, while the costs of the latter are not.

CAFE standards not only cost more than gasoline taxes to achieve a specific consumption reduction, they also reduce the marginal cost of driving a mile—and thus, ironically, increase vehicle miles traveled. The economics literature suggests that for every 10 percent increase in fuel efficiency through standards, people increase their miles driven by 2 percent. In fact, any efficiency standard that reduces the marginal cost of consuming energy will have an analogous effect, known to economists as the “rebound effect.”

One of the consequences of the rebound effect in relation to CAFE standards is a net increase in air pollution. According to one recent study, a 50 percent increase in fuel efficiency standards would reduce gasoline consumption by about 21 percent, but would increase net emissions of volatile organic compounds by 1.9 percent, nitrogen oxides by 3.4 percent, and carbon monoxide by 4.6 percent. — The Concise Encyclopedia of Economics

Conservation efforts are fine, as long as the cost of the conservation doesn’t exceed the cost of the commodity conserved. It just doesn’t make sense for me to spend $100 to conserve $75 worth of oil. That kind of reasoning only makes sense if we care more about oil than we do about people.

Whenever we talk about a resource, we’re really talking about a thing that’s used by people. Resources are used to make our lives better. We quite literally cannot improve our lives by conserving resources, we can only improve our lives by consuming resources. Which is not to say that we cannot over-consume; we certainly can. Buy a bag of Doritos and you’ll find that out. But it is important to keep in mind that the consumption and use of resources is what makes our lives better. And that’s what matters.

Economic Nonsense

Economic nonsense in the Times Online:
“The fundamental, and possibly fatal, flaw in all these well-meaning personal efforts [to reduce energy use] and well-intentioned government initiatives to tackle global warming is that the West’s entire strategy is based on restraining demand for, and use of, fuels. Yet this strategy will prove entirely futile unless the result is that the extraction and supply of these fossil fuels falls back as reduced demand puts downward pressure on their price.”

The mistake is in assuming that there’s actually some worthwhile point to reducing global energy consumption; there isn’t. Reducing personal energy consumption can make sense if you’re trying to save money, but reducing global energy use? It’s just silly. We don’t want to reduce the amount of energy the world uses, we want to increase the amount of energy the world uses. In a very real sense, energy use is the fundamental definition of wealth. The more energy we use, the longer we live, the better our lives are, etc… etc….

So the issue isn’t energy consumption so much as fossil fuel consumption. The author’s concern is that unless a reduction in demand leads to a reduction in supply, energy conservation won’t reduce the rate of fossil fuel consumption. And that’s exactly right. Why? Because oil is a commodity. A reduction in demand in location A just means that there’s more oil available for location B. Reduce demand in New York and more oil gets used in the Congo. The energy market is a global market and local variations have little effect on aggregate demand.

And from a strict conservation standpoint, shifting consumption from New York to the Congo would result in more pollution and significantly more waste. First-world industry is remarkably efficient and clean–we extract as much energy out of each barrel of oil as we possibly can (and we keep getting more and more efficient). But all that efficiency is expensive and time-consuming; third world economies just can’t match that level of efficiency. Shifting demand from New York to the Congo is a loss in terms of both efficiency and conservation.

But even that’s beside the point. Energy conservation on a massive scale is just poverty conservation. The point isn’t to reduce energy use, but to reduce fossil fuel consumption (well, it is for some people). And to do that, you need to replace fossil fuels with some form of alternative energy. But if we reduce energy consumption, then we reduce demand for fossil fuels, and as we reduce the demand for fossil fuels, we reduce the cost of fossil fuels, as we reduce the cost of fossil fuels, we reduce the incentives to develop and use alternative energy sources.

Alternative energy will only replace fossil fuels when alternative energy is less expensive than fossil fuel consumption.

But wait!!!! This only really works if the price of oil and the price of alternative energy actually reflects market demand and relative efficiencies. Subsidies, tax breaks, penalties, tariffs, and other restrictions will not work. A subsidy for alternative energy use, for example, doesn’t actually make the alternative energy more efficient or less costly than fossil fuel use, it only masks the cost difference by increasing the total cost of energy consumption. Drive up the relative price of oil, and demand will simply shift to locales that don’t penalize consumption.

So… if you want to see a real reduction in fossil fuel use, use more fossil fuels.

And don’t worry, we’ll never run out of fossil fuels. The price of fossil fuel consumption will rise to the point that further consumption doesn’t make economic sense. At that point, we’ll be using something else.

Note: It’s probably also worth pointing out the fact that the big issue surrounding fossil fuel consumption isn’t limited supply vs. unceasing demand (which is usually how the situation is characterized), but rather steadily increasing efficiency in combination with tightly controlled supply lines and unceasing demand. And while oil is very expensive right now, we only just (in the last two weeks) passed the previous inflation adjusted peak price set in 1979. Despite massive increases in demand and limited increases in supply, the adjusted price of Oil stayed relatively low for nearly 30 years–because increases in efficiency offset increases in demand. The same is generally true for all commodity prices, ingenuity tends–over the long-term–to negate price pressure from either supply or demand. This makes it exceedingly difficult to calculate global fuel reserves as the amount of known reserves are likely to last far longer than we currently expect them to.