Sunday, January 18, 2009

The price illusion

The Institute for Energy Research (IER) emailed me last week to warn me about the Obama administration's "green jobs" plan. The press release said that the plan would increase energy prices and actually cause total employment to decline. Furthermore, the release stated, renewable energy production has "stagnated" for the past 15 years, contradicting claims of vigorous growth.

The organization's assertions rely on a series of omissions. The first one the IER admits. It leaves out wind generation to claim that renewable energy growth has stagnated. Second, whether a massive government-led green energy program would lead to employment declines depends entirely on the assertion that money will be siphoned away from the nonrenewable energy sector of the economy. That now seems unlikely given the huge slack in the world economy and given that the plan is expected to be largely financed through deficit spending. But perhaps the most egregious omission is the failure to understand what market prices don't include in their signals to the economy and society.

For the IER, which dedicates itself to "free-market energy and environmental policy" and "private property rights," the struggling fossil fuel industry has succeeded entirely through ingenuity and pluck. The "scholars" (as they are called) at the IER seem to know nothing of the free work nature has conducted over the past few hundred million years in creating those fuels. Thus, the fossil fuel industry produces exactly nothing, but rather extracts the bounty of nature's work and delivers it to society. This is not an inconsiderable labor. But it amounts to privatizing the profits derived from the work of nature, while socializing the costs of using fossil fuels through such effects as global warming and toxic spills. (Here I should say that I do not think that this is a problem peculiar to the fossil fuel industry, but rather endemic in modern capitalism. However, the excuse that "everyone is doing it" should not shield the industry from reprobation.)

The price of fossil fuels (and especially recent prices) reflect virtually none of this reality; so perhaps the reason the people at the IER call themselves scholars is that their obsession with price renders them devoid of any practical understanding of the facts and frees them to focus on entirely theoretical matters just like the scholastic philosophers of old.

However, to focus entirely on the price of various fuels without contemplating their long-term sustainability, their environmental side effects, and their effects on the political and economic structure of world society is the equivalent of killing all but your favorite child so you can direct all your attention to him or her.

Still, even if we focus just on price, one would barely know by reading the IER's report on the green jobs proposal that oil had recently swung from under $50 a barrel at the beginning of 2007 to almost $150 last July to under $40 today. Similar price swings have taken place in the natural gas and coal markets. Such volatility is usually a sign of a system in distress. And, such instability makes it difficult for governments, businesses and consumers to create long-term plans.

Moreover, the ultra-low fossil fuel prices of today are a product not of exploration success, but rather economic implosion which is killing energy demand at a colossal pace. These prices are not a sign of plenty, but the result in part of the huge stress of high energy prices on the world economy in the last few years--stress that ultimately helped to tip a fragile economy into the first debt deflation since The Great Depression.

And so, the prices we are seeing for fossil fuels are creating an illusion of plenty that masks the central issue of our time: How do we move from our nonrenewable energy economy to a renewable one and do it quickly enough to avoid a catastrophic and rapid decline in the total energy available to human society?

Why is a rapid decline possible? Because prices for finite resources almost always reflect the here and now rather than long-term supply prospects. Even though fossil fuels are finite, and we are much closer to the end of the fossil fuel age than we are to the beginning of it, fossil fuel prices reflect not their growing scarcity but their temporary oversupply. This an illusion of the first order, and one filled with perils of the most extreme kind.


mattbg said...

I think you can include almost all forms of energy in the "harvesting nature's work" bucket. After all, we didn't create the air currents that make wind energy possible, and if wind currents change then we don't harvest any energy. Of course, renewables are a good choice because they are renewable on a more favourable scale than oil (which is a renewable resource, but it just takes too long to renew!)

Diesel, gasoline, etc. are things we produce. Supplying an oil that fits a reliable standard such that we can take what arrives an run it through a process that is designed to work with oil of that standard is a product. We're not just pulling stuff out of the ground and throwing it into an application.

Henry Warwick said...

Kurt wrote:

Still, even if we focus just on price, one would barely know by reading the IER's report on the green jobs proposal that oil had recently swung from under $50 a barrel at the beginning of 2007 to almost $150 last July to under $40 today.

This is true, however: as oil hovers around $40 a barrel, it actually demonstrates a significant increase in energy prices - not in terms of 2008 / 2009, but from 1998 / 2009.

In 1998, oil bottomed out at $10 a barrel. Assuming this $40 hover position is the new bottom, then that means over 10 years the nominal price of oil went from $10 / $40 - a 400% increase, or, if using the rule of 70, a price inflation of 35%, per year for 4 years.

So, in fact, WE DO NOT have cheap oil. At all. We have very expensive oil, even at $40 bbl. If the price drops to $20 bbl nominal price, then we're talking 17.5% inflation for 4 years. That's pretty extreme inflation.

So, yes, $40 is cheap compared to $150, but its crazy expensive compared to $10.