Should oil be cheap?

Update: An alternative take on this issue, in light on the financial crisis now looming over our nation, appeared on CNN a few days ago.

There was a great article on Business Week, published July 23. The article is called, “Should Oil Be Cheap?“.

Basically, the article argues that there is a case to be made against cheap oil, and the crux of that argument goes something like this:

Expensive energy is a powerful medicine. It may hurt when taken, but it brings long-term cures for a host of ills. It compels companies and people to put fewer miles on the car, ditch the SUV, or install more efficient heating, as Eastern Maine Medical Center in Bangor did: The hospital saves $1 million annually with a system it installed two years ago. Higher costs are beginning to nudge America away from its traditional traffic-congested suburban sprawl to denser, less car-dependent communities. Utah has a government-sponsored bike-to-work program. “When the Republican governor of the reddest state in the union is promoting bicycling as a preferred mode of transportation, you know people are paying attention to the price signals,” says Keith Bartholomew, professor of urban planning at the University of Utah.

These changes are saving lives—fewer traffic deaths—and improving health as people get out of their cars. A study from Washington University in St. Louis suggests that 8% of the rise in obesity since the 1980s was due to low gas prices, which led to less walking and biking and more restaurant meals. Silicon Valley engineer Andy King parked his Chevy Suburban in favor of a bike for commuting and says he has dropped 35 pounds since February. “It’s good for my body and soul,” King says.

High energy prices also water the flowers of innovation, making investments in alternatives pay off and juicing the search for more oil. Military-funded researchers have made jet fuel from plants. Toyota (TM) and General Motors (GM) are testing plug-in hybrid cars that can run 40 miles on electricity alone. Companies are building vast expanses of mirrors in the desert to make steam, and thus electricity, from the sun. There are new systems to control power consumption by homes and businesses from afar and programs to insulate inner-city houses, providing energy savings—and jobs. The U.S. uses just over 20 million barrels of oil per day heating homes, powering industry, and fueling cars, trucks, and planes. Energy-saving initiatives, “could easily take 4 million to 5 million barrels a day of demand off the market in 10 years,” says Stanford professor Hillard G. Huntington, executive director of the Energy Modeling Forum, a group of energy experts.

These are certainly valid points, ones I hadn’t really considered prior to reading the article. I think the bigger point that is entirely omitted from this report is the economic tragedy that the US inflicts upon itself by being dependent upon the resources of hostile foreign regions in order to function. Oil is the lifeblood of the US economy today, and only about 30% of that oil is generated domestically. Now, if we truly had the capacity to switch to all-domestic oil, it wouldn’t matter so much where it came from. But the fact is we depend on vast amounts of it that we have no way to produce here even if we needed to. Shifting away from that dependence is critical.

The article continues:

You can see where this is going. Wall Street has. With oil demand slowing and supplies headed up, prices are off more than $20 from their July 11 record of $147.27. “I don’t think anyone believes prices that high were here to stay,” says Massachusetts Institute of Technology economist A. Denny Ellerman.

Just as the low prices of the late 1980s and ’90s undid some positive effects of expensive oil, the mere possibility that prices could fall is weakening the market forces pushing toward greater energy efficiency. What really drives behavior is not the actual price, but the perception of where costs will be over the long term. That helps explain why Americans didn’t cut back while gasoline prices climbed a few years ago. “After Katrina, gas got close to $3, and then prices moderated,” says Rajeev Dhawan, director of the Economic Forecasting Center at Georgia State University. Only when gas broke the $4 barrier, with no relief in sight, did the wake-up call come.

Strong as it is, that call is being muted by uncertainty about where prices will go. Some experts see $200-per-barrel oil in their crystal balls; others predict $75 or lower. As a result, technologies that should make economic sense at $100 per barrel aren’t being funded, says venture capitalist Vinod Khosla. “We are getting the worst of both worlds—high prices and low investment,” says Khosla, a co-founder of Sun Microsystems (JAVA) and now a backer of alternative energy ventures.

That’s why Khosla and many economists and energy experts are pushing the idea of a floor on the price of oil. The certainty of a relatively high price would stimulate enough investment in alternatives, efficiency, and new supplies to keep future prices from rising much above that level, Khosla argues. It adds no new pain, since the tax would start only after consumers and companies have already gotten considerable relief from today’s prices. It would have been better to tax citizens decades ago—forcing Americans to become more energy-conscious—but that was a near-impossibility politically. Since external forces have now accomplished the same thing, though, a floor is a good second-best, economists say.

So, uncertainty in the price of oil is limiting investments in alternative energy sources. After all, if it did get cheap again, we wouldn’t have to shift.

But in my mind this is the vicious cycle we’re already living with. What the market really needs is certainty and reliability. That’s the beauty of renewable energy! We can eventually build up whatever capacity we need of these infinitely renewable resources, and the prices will have no reason to swing violently. In fact, the only significant swings a renewable energy market is likely to experience are DOWNWARD, introduced by innovative new technologies that a competitive marketplace ALWAYS develops.

Now, as for the details of creating a tax floor on the price of oil… I’m not sure how well that would work. Whether oil prices are likely to fall enough to actually bring this tax into effect is hard to predict. Global demand certainly isn’t going down any time soon. As for funding alternative energy infrastructure with the proceeds of the oil price-floor, I don’t know if that’s a good idea either.

The biggest problem with it is that it may never be collected, so while it sends a signal to the market to continue investing in the transition to a new energy ecomony, it doesn’t necessarily ever provide funding to support that transition.

So, I think the best thing would be to permanently earmark that tax to repaying the national debt. Currently our national debt is over $9.2 TRILLION, and we spend $237 BILLION each year in just INTEREST on that debt. [UPDATE] And, this year we’re expected to break all the records for deficit spending, adding another HALF TRILLION dollars in debt.

For more information about that, check out perotcharts.com, one of the most informative reads available on the net. Directly linking these revenues to debt finance perevents politicians from getting their greedy hands on them and spending them on wasteful entitlements.

In fact, this could be a real boon to the economy! If the price of oil did fall to say, $85 a barrel, and we started to collect $5/barrel which was funneled directly to the national debt, the dollar would strengthen.

A stronger dollar means cheaper oil, which means more tax money to pay off the national debt! If this ever happened it would be a tremendous benefit to the nation! Moreover, the tax-floor on oil prices could be designed to expire or significantly drop if the national debt was ever fully retired. The positive effects of this are so strong, in fact, that I wonder if it would be worthwhile to go ahead and institute this tax-floor on oil with an even higher starting point, say $130/barrel, so that it can be collected right away, then reduce it incrementally as the national debt is retired.

I would propose that upon the retiring of the national debt, the tax floor drops by about 10%. Then the remaining revenue stream is dedicated to a permanent national endowment, which could function in similar fashion to the endowments that most universities operate on. Two great large-scale examples of this are the Permanent University Fund that is used to support UT-Austin and Texas A&M University, and the Alaska Permanent Fund, which results in a dividend paid to all Alaskans of about $750 each year. For a family of five that’s about $3750 extra cash every year!

The interest / dividends, from the National Endowment could be used in tons of ways. The government could issue every American a check for a slice of it, like the State of Alaska does, or it could use the dividends to invest in education, research, infrastructure… you name it. I don’t really care what the fund is used for, so long as the principal of the endowment continues to be expanded, and the balance cannot be touched.

Now, like everything else in the universe, there could be a circumstance in which the principal balance of this national endowment should be used. I would suggest that it be totally off-limits except in the case of an invasion or attack against the 50 states. Not a terrorist attack, an actual, severe, life threatening, city destroying invasion. Then it could be used to fund a surge in defense materials.

As the article points out, this tax could result in a huge shift to coal and other non-renewable fuels, thereby reducing the potential it has as an environmental benefit. They recommend taxing the carbon instead of the oil itself. I think this is unnecessary. Coal isn’t very suitable for use in cars (the main user of oil), and even gassification isn’t that useful since it’s very expensive and produces natural gas, which cannot be used in cars without significant infrastructure shifts. Shifting to natural gas for transportation would be a good call anyway, so action that spurs that change offers a net benefit. Instead of worrying about carbon, I’d simply put the price-floor on all non-renewable fuel imports on a minimum dollar per joule basis. The goal needs to be to shift to technology that is economically sustainable, and then over time making it environmentally sustainable will be a profit-driven move.

The truth is, even with a high price-floor, we’re not likely to collect much of tax until a significant shift to alternative energy has dramatically reduced demand. But the sooner we begin the shift away from dependency on foreign fuels, the better off we’ll be. And if a price-floor on oil is what the energy industry needs to jump start their investment in that shift, then let’s have it!

Comments are always appreciated!