How New Energy Dynamics Are Fueling the Economy

How New Energy Dynamics Are Fueling the Economy
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The seventh part in a weekly series of articles RCP is publishing through Election Day to explore policymakers’ decisions regarding this crucial sector of the economy

In 1973, the members of the Organization of the Petroleum Exporting Countries (OPEC) officially banned oil shipments to the United States. In a matter of months, the embargo triggered fuel shortages and price surges, with the price of oil quadrupling from $16 per barrel in 1973 to $65 (adjusted for inflation) the following year. The resulting energy crisis has become the stuff of political legend, with familiar images of “no fuel” signs and interminable lines at gas stations across the country.

In addition to wreaking havoc on the economy both at home and abroad, the oil crisis of 1973 helped put in motion the complex dynamics surrounding the cost of energy and economic growth -- factors that continue to frame our political debates today. Fears about dependence on foreign oil, energy shortages, and even “peak oil” are still with us, while consumers continue to balk at the prospect of paying more at the pump. Insert into this dynamic a growing call to curb carbon dioxide emissions to combat climate change and our current energy dilemma comes into full view.

Though worries about global warming are (relatively) new, the idea that we should both conserve and find alternatives to conventional energy are not. Similarly, the desire to mitigate, if not eliminate, environmental externalities is an old quest. But if our political discussions about energy in many ways still echo those of the 1970s, something essential has changed in the politics of energy.

In 1974, the price of gasoline hit approximately $2.50 per gallon in today’s dollars, sending consumers and policymakers reeling. Today gasoline is on average $2.20 per gallon, having exceeded $3.50 in 2011 before the price collapse. Savor the point: Today’s “low prices” are not, in fact, at historical lows. On the contrary, they are in the same neighborhood as the gasoline prices that caused the policy panics during the 1970s. So what’s different this time around?

The answer is that in today’s expanded economy we spend less money on energy relative to other goods and services. One of the great innovations of modernity was to move economies away from costly, inefficient, unhealthy, and environmentally deleterious forms of energy—especially burning wood and coal inside homes and factories. That trend continues today, as innovations in extracting oil and natural gas have dramatically lowered the cost of energy production.

Something else happened, too: Energy consumption spiked. While consumption remains high today, the cost is a paltry 4 percent of the average American family’s overall expenses. The result? We are now more insulated from the vicissitudes of energy markets; we can absorb price shocks better than we once could, meaning that $2.50 per gallon doesn’t catapult us into a recession.

Obviously, this is a good thing. Consumers spend less and less (relatively speaking) on energy, spurring investments in other sectors of the economy. Production, meanwhile, benefits from increased efficiencies, stimulating manufacturing and lowering the price of other goods and services. In short, energy efficiency is good for the economy, since greater efficiency means reducing the input of natural resources for the same output.

One paradox is that increasing energy efficiency tends to cause an increase in energy consumption. This, in turn, has increased our carbon footprint — since hydrocarbons still constitute more than 80 percent of America’s energy supply. That leaves policymakers with three options: encouraging conservation; raising the price of hydrocarbons; or moving us off hydrocarbons onto alternative sources of energy. They are not mutually exclusive, and all present their own challenges.

For starters, the sheer level of conservation needed to make significant headway in lowering carbon emissions is staggering and would require a cultural — not just economic — shift on a global scale that seems unlikely (especially in the short term), to say nothing of its impact on economic growth.

The problem with the second option is that raising the price of energy has obvious adverse economic effects, not to mention political consequences. True, we are more insulated from energy costs today than we once were, but aggressive proposals to combat climate change by dis-incentivizing fossil fuel use mean increasing the cost of energy enough to alter people’s behavior. Also, higher energy costs disproportionately impact middle- and lower-income families so that any price increase here will either be punitive for the most vulnerable in our society or require policy manipulations to transfer those costs to higher earners in the form of taxes.

None of this makes for popular politics. Consider, for instance, that the gasoline tax, which funds our highway system, has not been raised since 1993 and has decreased by 20 percent adjusted for purchasing parity. No surprise that our highway infrastructure is starved for cash. For this reason, many liberals and even some conservatives agree that raising the tax is a good idea. But good luck to the politician who decides to run on that platform.

That leaves the third and most promising option: new technology. Set aside such technological solutions to climate change as carbon sequestration and geoengineering, which take us from economics into the truly speculative reaches of science and engineering. It’s true that technology has increased the efficiency of alternative sources of energy by impressive margins in the past few decades. The cost of solar panels has dropped nearly three-fold in under a decade. Nevertheless, it is proving technically and economically difficult to effect large-scale changes in how electricity, for example, is supplied. The truth is that, short of dramatically reorganizing our economy and ways of life, we’re still a long way from a fully “green” economy. The inherent difficulties involved in scaling wind and solar — whatever their other benefits and usefulness at smaller scales — have led both Google and Bill Gates to advocate for massive increases in R&D to develop as-yet unknown “miracle” technology solutions.

Our environmental fate may, indeed, be in the hands of technological miracle workers. But one thing to keep in mind is that it’s not always easy to predict where these miracles will arise. The irony of the last decade is that we have decreased our dependence on foreign oil, increased our energy efficiency, and even begun to chip away at our carbon footprint thanks in large part not to alternative sources of energy or large-scale behavioral modification but, rather, to innovations in the oil and gas industry. Developments in “smart drilling,” which have unleashed the power of hydraulic fracturing (“fracking”), have lowered the cost of energy and altered the geopolitics of oil by making America an energy exporter once again — all while decreasing carbon emissions by increasing reliance on natural gas.

So we’re a long way from 1973. Where does this leave us economically and environmentally? Lower energy costs may be beneficial but they are not sufficient to drive our economy — and, as we learned last year, if prices go too low, they can create economic problems for producers. Meanwhile, we’re still searching for that miraculous low-cost, maximally efficient, carbon-neutral energy. But that is not likely to arrive anytime soon, no matter who moves into 1600 Pennsylvania Ave. on Jan. 20.

M. Anthony Mills is the editor of RealClearPolicy.

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