Friday, July 01, 2005

The Wrong Lessons?
Last night over dinner with friends we discussed some of the differences between the oil crises of the 1970s and our current situation. Given editorials such as this one from Wednesday's Wall Street Journal, it's apparent that the lessons from that earlier period need to be assessed and updated to account for the changes of the last several decades.

Some of the key learnings from the 1970s have held up well:
  • Direct government intervention in energy markets to affect prices is counterproductive, in both the short- and long-term.
  • Diversification of supply is a top priority for enhancing energy security, balanced against proximity and reliability of major suppliers.
  • The price-elasticity of demand for oil products is not zero, but the response takes time, as consumers and industry readjust their practices to accommodate higher energy prices.

But, as exemplified by the WSJ editorial, much of the conventional wisdom about alternative energy needs to be revised. It is fair to say that government investments in alternative energy technology (e.g., wind and solar power) or production (e.g., shale oil) played little or no role in ending the energy problems of the 1970s. Decontrol and the free-market stimulus to new production, along with a good deal of fuel-switching to natural gas, effectively neutralized OPEC's market leverage by the mid-1980s. But that does not mean that the alternative energy provisions of the pending Energy Bill in Congress should be likened to the Synthetic Fuels Corp. and other Oil Crisis dead ends.

We find ourselves in very different circumstances from those of 1979. Alternative energy technologies that were clearly not ready for "prime time" then are today moving into the market, some with subsidies but others on their own merits. Wind power is almost competitive with gas-fired power plants, on an incremental basis, and Canada already produces 40% of its oil from oil sands deposits. While continued taxpayer investment in major new systems such as hydrogen is still necessary, other alternative energy sources would benefit more from legislation to streamline the permit approval process. This is particularly true for LNG and wind power.

At the same time, conventional oil supplies offer no silver bullets. At their peaks, the North Slope and North Sea contributed over 8 million barrels per day to non-OPEC oil production. The Caspian Sea region and the Arctic National Wildlife Refuge might provide a bit more than half that much in new production.

Finally, the Strategic Petroleum Reserve, a cornerstone of 1970s energy policy needs to be totally rethought. It still serves as an insurance policy against a catastrophic disruption in oil imports, and the Administration has been right to resist calls to release SPR oil to moderate prices. However, commercial stocks have fallen as a function of increases in SPR levels, because the present structure of the SPR creates a disincentive for holding commercial inventories of oil. Providing positive incentives to increase the latter would do more to dampen price volatility, while positioning oil precisely where it would be needed in the event of a supply shortfall.

Simply put, while the current energy market bears some similarities to the oil crises of the 1970s, dealing with it effectively requires critical reassessment of what we think we learned from our previous experience with high oil prices. Much has changed in the intervening thirty years, and we have new tools available to us.

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