A Possible Solution to Sudden Oil Price Spikes

One of my recent essays discussed the relationship between high oil prices and recession. Consumers who suddenly find themselves paying more for fuel are hit with the equivalent of a stealth tax, leaving less money available to fuel domestic growth through purchases or investments. Thus, unsurprisingly, there is a strong historical link between escalating oil prices and economic recessions.

But despite the financial pain (in fact, because of it) there is a major upside to higher oil prices. Consumers do respond to the price signal, and this response can provide some protection against further price spikes.

In this essay, I point out how we can mitigate against the effects of sudden price spikes, advocating for a better price signal in conjunction with long-term planning in order to allow consumers to prepare themselves in advance.

Consumers Respond to Rising Gas Prices

As they did during the oil price spike of 2008, consumers are once more demonstrating a response to higher oil prices.

First, they simply cut back on driving:

Drivers start to cut back on gas as prices rise

Across the country, people are pumping less into the tank, reversing what had been a steady increase in demand for fuel. For five weeks in a row, they have bought less gas than they did a year ago.

But that story also illustrates that the response to the price signal is generally not fast enough:

People are still taking a hit, even as they conserve gas. That’s because gas prices are going up faster than people are cutting back. Gas is 32 percent more expensive than it was in April 2010. In all, Americans are paying roughly $340 million more per day to fill up than they did a year ago.

In addition to cutting back on fuel purchases, consumers also start looking at more fuel-efficient vehicles. Demand for hybrid and electric cars is higher than ever, but demand for diesels — long popular in Europe due to favorable taxes on diesel fuel — is gaining steam in the U.S.:

Diesels: Mainstream Competitors to Hybrids?

With gas prices approaching $4 a gallon in many states, drivers are inquiring about fuel-efficient options that go beyond hybrid vehicles and public transportation. More so than in 2008, drivers are ready to get behind the wheel of diesel vehicles, which in some cases are more costly but also offer more miles per gallon. Popular car leasing website LeaseTrader.com says search demand and lease takeovers are up for several diesel models compared with activity from 2008.

Demand for compressed natural gas (CNG) vehicles is also climbing:

Ford Seeing Increased Demand For Natural Gas-Powered Trucks, Vans

With gasoline approaching, and in some areas surpassing $4 a gallon, Ford is reporting high interest in its natural gas-powered vehicles. The company currently offers its E-Series fullsize vans, Super Duty trucks, and Transit Connect compact vans with a Compressed Natural Gas (CNG) option.

Toward a Better Energy Policy

These are all developments that will ultimately slow U.S. demand for petroleum, but economic havoc can ensue while we wait for these developments to evolve. The long-term fatal flaw in U.S. energy policy is that it is based on delivering energy to consumers at the lowest possible cost. This sort of thinking is flawed, and it leaves us ever more vulnerable, and less-prepared as a nation for higher oil prices.

This is the reason I favor a more proactive approach to managing fuel prices. When they rise sharply, consumers are unprepared and they are suddenly hit with unexpected pressure on their budgets. If they knew the price increases were coming, they could better prepare themselves instead of listening to pandering politicians continue to promise a return to happier times of $1 gasoline by engaging in wishful thinking. By implementing the idea of trading higher gas taxes for lower income taxes, 1). Consumers would know the increases are coming and could plan accordingly; and 2). More of the money generated by that price increase would stay within the U.S.

Traditional Political Views on Energy Are Flawed

With oil having risen in price by an order of magnitude over the past decade, I believe the days of ‘cheap’ oil are behind us. Yet instead of responding with proactive long-term planning, we try to cling to the past with silly schemes like tapping the Strategic Petroleum Reserve to ease prices for consumers. Or, we engage in military action to make sure the oil keeps flowing. In response to high prices, our political leaders engage in magical thinking, and they look for scapegoats. One side will claim that oil prices are only high because we haven’t developed our resources to the fullest extent. The other side will claim that they are high because of our failure to invest enough money into alternative energy.

I believe both views are wrong. The first view is wrong because global demand for petroleum is large and growing, and we can’t add enough to the mix to significantly impact global oil prices. That isn’t to advocate leaving our resources untouched, it is simply an observation that developing our resources isn’t going to return us to the days of $2 gasoline.

The second view is flawed because it is simply more expensive to produce renewable energy. This is almost universally true, which is why so much intervention is required to increase the renewable energy share in our energy portfolio. So I don’t believe cheap renewable energy is going to replace expensive fossil fuels. I actually think that expensive renewable energy ultimately replaces much more expensive fossil fuels (albeit at a lower level of consumption than today’s).

At What Price Will Renewables be Competitive?

People often ask me at what price point I believe various renewables will be competitive. I think those price points are farther off than most people think. Consider that in Germany today gasoline sells for $8.35 a gallon. That tells me two things. First, people will continue to drive at much higher prices than we are paying today. They will just continue to make difficult adjustments and that will continue to take its toll on economic growth. But the more important indicator to me is that renewable energy has not ridden to the rescue in Germany at that price point. Electric cars haven’t filled the autobahns, nor have E85 or biodiesel-fueled vehicles. That day may come, but once again the response is slow and those prices take their toll on consumers in the interim.

On the other hand, those high prices have long influenced decisions in Europe around energy consumption. Europeans have opted for more fuel efficient cars, mass transit, and shorter commutes to work, and as a result European per capita consumption is about half that of the U.S. So the price mechanism undoubtedly works. Indeed, it works more effectively than anything else at getting consumers to change behaviors.

Conclusion

While consumers do respond to price hikes on fuel, the response lags, often because of a belief that prices will fall back to historical levels. Pandering politicians don’t help matters by suggesting that prices are high for reasons other than supply and demand. By doing so, many consumers are left with the belief that just as soon as our lawmakers get their hands on those speculators and oil companies fixing prices, or the environmentalists blocking development — they can continue to consume like it was still 1999.

By. Robert Rapier

Source: R Squared Energy Blog