As the horrible devastation of Hurricane Katrina pushes the price of gasoline to ever-higher levels, the Bush Administration has stated that they intend to raise federal fuel efficiency (CAFE) standards even higher to promote greater energy efficiency and lower oil consumption.
The problem with this is that it simply won’t work. There’s a dirty little economic secret that few know about but has a profound effect on the world economy: Increasing efficiency doesn’t decrease consumption.
James Glassman at Tech Central Station provides an explanation for this phenomenon:
“The pursuit of efficiency,” write Peter Huber and Mark Mills in “The Bottomless Well,” their superb book on the future of energy, “has been the one completely consistent and bipartisan cornerstone of national energy policy since 1970.”
We’re told that higher mpg can even defeat our enemies. In a recent article that linked oil dependency with terrorism, Fareed Zakaria, editor of Newsweek International, concluded, “It’s true that there is no silver bullet that will entirely solve America’s energy problem, but there is one that goes a long way: more fuel-efficient cars. If American cars averaged 40 miles per gallon, we would soon reduce consumption by 2 million to 3 million barrels of oil a day.”
Increases in energy efficiency have been the rule in the United States for a century — and especially in the past 30 years. But, as Huber and Mills write, “Efficiency doesn’t lower demand, it raises itâ€¦. Efficiency has come, and demand has risen apace.”
Economists wouldn’t find that concept as strange as it may seem. Efficiency tends to lower costs – and lower costs tends to make people use more of something. Indeed, the numbers bear out this theory – over the past 30 years energy usage has increased at the same time energy efficiency has increased. Modern cars get significantly better gas milage than the gas-guzzling monstrosities of the 1970s – but the usage of gas continues to increase. Huber and Mills’ book is a fascinating look into the economics of energy, and why conventional energy policy tends to make things much, much worse.
For instance, take raising the CAFE standards. More energy efficient vehicles means less pollution and less gasoline usage, right? The problem is that increasing fuel efficiency requires technical tradeoffs in design. Instead of using stronger steel-frame construction, a manufacturer might use lighter aluminum that’s more likely to crumple in an impact. The difference in weight and fuel efficiency comes at the expense of passenger safety. Engineers understand these compromises, but politicians do not.
The economics also don’t make much sense once one gets beyond the surface of the issue. Newer cars are more fuel efficient than older cars. However, more fuel efficient cars can be more expensive, and the costs of increased fuel efficiency end up getting reflected in the sticker price. If someone has to keep running with a 1990s era car with less stringent emissions controls and less fuel efficiency, that represents less benefit than had that person gone to a car that would have been slightly less efficient, but cheaper.
Don’t get me wrong, fuel efficient vehicles make a lot of economic sense, and car prices are quite low now. The idiots who bought that road-hogging Hummer H2 a few years ago are finding themselves taking up the tailpipe every time they fill the tank, and good luck finding a car dealership that would be willing to accept one of those beasts as a trade-in. That’s the market in action – fuel efficiency is a selling point regardless of what the current CAFE standards are.
And that’s the other issue here – gasoline is in the middle of a price bubble. Speculators have driven the price of oil to a level that’s substantially above its true market value. Megan McArdle believes that $30-$40/barrel oil is the equilibrium price, and I’d tend to agree with that assessment. At that price, reserves like the tar sands of Alberta become economically feasible to extract. Canada could easily end up being the next Saudi Arabia at that price levels – except with nutty socialism replacing virulent Wahhabism.
McArdle points out a fact about price levels and commodities:
It is an odd fact of human psychology that if tight supply (or excess capacity) persists for long enough, people will start acting as if the trend line is permanent. It is odd because “long enough” isn’t very long. Five years ago, people were talking about $5 a barrel oil, not realising what is perfectly obvious in hindsight, which is that low oil prices were not a result of being overtaken by a bold new future, but of the widespread recession in Asia that followed upon the 1997/8 financial crisis. Now they’re talking about $100 a barrel oil.
Neither prediction was particularly realistic – while we may be getting close to Hubbert’s Peak that’s only for cheap and easy oil. The Canadian tar sands aren’t cheap or easy, but it will provide us with plenty of energy until we can find an alternate source of energy. Acting in a panic tends to produce poor public policy, and that’s one of the reasons why it’s important not to overreact now.
What are the solutions to our energy problems? The biggest is our lack of refinery capabilities. We’re already running American refineries at nearly 98% capacity, and Katrina will put us much further behind. We need to build more refineries, but environmental regulations have made that nearly impossible. People want gas, but they don’t want a refinery near their house. Furthermore, our ports are heavily populated, and refineries naturally need to be close to where the crude oil enters the country to avoid the costs of shipping crude over land. Unless people are willing to budge, gas prices will remain artificially high.
Furthermore, as always, government adds a significant amount of cost – not just in taxes, but in regulations. A blend of gasoline for use in Chicago can’t be used in Los Angeles – meaning that refineries have to produce “microbrews” of gasoline that can’t be shipped freely across the country. If Los Angeles has a shortage of gas, and Chicago has a glut, you can’t ship more gasoline from Chicago to Los Angeles to make up the difference. That sort of artificial inefficiency makes the refinery situation even worse and dramatically increases the cost of gasoline.
The rise in gas prices is more reflective of poor public policy than anything else, and the continuing calls for more the same will only make things worse. Efficiency helps the consumer, but it doesn’t reduce the consumption of oil. Measures like price caps only ensure that consumption increases and supply goes down – putting gas stations (who only make a miniscule profit on gas sales) out of business and making life difficult for all. The market has already evolved a system for dealing with changes in commodity supplies – prices. The price of gas is helping to drive down demand, which will increase supply, which will eventually lead to market equilibrium. Trying to control this process is like trying to legislate a hurricane.
Over the long term, energy independence lies with clear nuclear power – which is why countries like China are working hard at building a network of clean pebble-bed reactors that can produce massive amounts of power without producing pollution or significant amounts of nuclear waste. Even the French get this right – 70% of their energy is nuclear. An efficient and effective nuclear program based on standardized pebble-bed reactor designs is the Holy Grail of energy policy – when electricity becomes cheap, things like electric cars become economically feasible. Right now all the electric cars in the world would just shift emissions from cars to power plants rather than reducing pollution.
The problem is not SUV drivers, the problem is that we’re caught between our need for energy and our own irrational fears. Forcing everyone into hybrid cars won’t reduce energy usage, it will increase it. Electric cars only shift the source of pollution from gasoline to our already over-extended power grid. We’re trying to have a 21st Century economy on an energy infrastructure that is stifled by onerous environmental regulation and the completely irrational fear of nuclear energy.
We can’t have our cake and eat it too. If we want cheap energy that doesn’t fuel terrorism, we have to start looking at economically and technologically feasible ways of doing it here at home. Rather than force yet another rounds of increased CAFE standards, President Bush needs to be making the case for bringing the US into the 21st Century – creating a network of safe and efficient nuclear reactors that can not only provide our homes with power, but also power the next generation of fuel cell, hydrogen, or electric vehicles.
As always, politicians prefer to make highly-visible gestures that ultimately don’t fix the problem – and more often than not make them worse. We can’t force people to drive hybrid vehicles, nor should we. What we can do is let the market do what markets have always done – utilize the laws of supply and demand to create a natural equilibrium.