Sunday, February 26, 2006

Bush, Kulongoski, and renewable fuels

President Bush says we are addicted to foreign oil, and he wants to reduce our dependence on it. Governor Kulongoski says he wants to increase 25% of Oregon's fuel consumption to be renewable energy.

Both are misguided; both misunderstand basic economics.

We hear a lot about the risk of depending on the middle east for oil. When we buy oil from Arab nations we fill the government coffers with dollars that in some cases are used by those governments to fund terrorism. If we cut our consumption by 10%, I've heard it said, we could get by without oil from the middle east, and bring them to their knees economically.

It wont work. If we reduce oil consumption, the global demand for oil will obviously go down, and the price will go down a bit as well. So would it have much effect on Arab oil nations? No.

Arab nations are the world's lowest cost producer of oil. A lower global oil price would only hurt the higher cost producers, who might find the new equilibrium price of oil above their production costs. Arab nations would sell the same amount of oil, but perhaps at a slightly lower price.

So, if the point of reducing our dependence is to reduce the cash flow of terror sponsoring Arab nations, it simply won't work. The middle east produces oil for about $5 a barrel. Reduce global demand all you want, the Arab nations will be the last man standing becuase they are the lowest cost producer.

If the point is to make sure our economy isn't vulnerable to political events in the middle east that might disupt oil supply, it also doesn't make much sense. So we are supposed to consume higher-priced domestic energy sources rather than Arab oil in case the Arabs stop selling their oil to us?

It doesn't make economic sense, because every form of alternative energy costs more than oil, so the only way they get produced is with government subsidies. Subsidies are bad policy.

Take ethanol, as an example. Ethanol production in the U.S. gets subsidized to the tune of 50 cents a gallon. Guess what the major input in the production of ethanol is? Yup, energy - oil. Lots of oil involved in the planting and harvest of the corn, transporting it and distilling it into ethanol. Studies have been conducted that add up all the oil involved in ethanol production and found that each gallon of ethanol uses more than a gallon of oil!

So subsidizing ethanol production actually INCREASES our demand for oil!

But, you say, if we subsidize the production now, then we will figure out new and better and more efficient ways to produce it, and we will be ready to convert if some event in the middle east cuts raises the price of oil.

That sounds right, but the subsidy is not necessary, unless you believe in the all-knowing ability of government to correctly anticipate future technological advancements. How do we know ethanol will be the best alternative energy source? How about wind, solar, geothermal, natural gas, or cold fusion? Nobody knows what technology will be developed on any of these things. For the government to choose now and subsidize one or more of them requires a much greater faith in the efficacy of political decision-making than I have (or than is warranted by its track record.)

The oil industry is extremely profitable. There is a tremendous incentive for private industry to pursue alternative energy technology. As a general rule, if there exists a huge incentive to engage in an activity, no subsidy is required.

So why do politicians like Bush and Kulongoski love to subsidize alternative fuels? Well, the agricultural industry has a very effective lobby. They get billions each year in farm subsidies of one sort or another.

This is just another.


rickyragg said...

I find it unlikely that oil production is not subsidized.

Don't you?

Jim Evans said...

Rob, your analysis is good, and I appreciate its significance. But what about coal production and converting it to more usable forms of energy? The United States has a 200 year supply by some estimates. Substituting liquified coal would help restrain the price of oil(demand substitute). At present $60 plus cost per barrel, coal may be economical without subsidy by the government. Also I would rather have the money stay with a U.S. company than a Middle Eastern country.

MMW said...

It's worth noting that not all agriculture is the same when it comes to subsidies. Certain crops, mostly grown in the midwest and south (wheat, corn, rice), get MAJOR govt subsidies. Most so called "minor" crops (apples, mint, asparagus, etc.) get very liitle or no govt subsidies.

Dare!PDX said...


Your wrong in your analysis in several ways. First off - our economy IS addicted to foreign oil!!! We are dependent like a junkie on oil that props up dictators and extremists the world over. We are undermining and self-destructive in our importation of foreign BTU's of hydrocarbon fuels. No other nation in the world would allow this much of their GDP to be exported to people who want them dead. China won't; no one in Europe will; we are alone in our insistance on oil when simple fixes lead everywhere else.

I would support the President whole-heartedly in laying a $5 a barrel or even a BTU tax on energy imports to move over to university level research and infrastructure grants for sustainable fuels.

Second - Ethanol is a good deal all the way around. Prior to Katrina shutting down the refining capacity of the southwest wiping out our supply of ethanol to off-set the drop in available petro-gas ethanol was actually cheaper than gasoline. Ethanol is a true alternative (price, performance, and infrastructure use) for gasoline when gas is above about $1.75 a gallon. It also is used alot to blend off-spec gasoline into spec as it is a superior product to standard gas when looking at octane rating (Arco gasoline is blended with 10% ethanol year round to make it meet required octane requirments).

Third - Ethanol plants are not a place that you ship corn to. They are a place to put agricultural waste products and non-food grade corn instead of a land fill. If corn doesn't meet a quality for consumption (such as it's spoiling or it's genetically modified and barred from human food-supplies)it's ethanol bound and at a profit. It support agriculture and keeps this economic output compounding within our own borders.

Other examples of profitable, self-sustaining Ethanol operations: Coors brewery in Colorado set up a ethanol plant to reprocess their mash before sending it off as waste. Cellulose ethanol plants (the ones Prez. Bush talked about in the state of the union) take wood waste and paper waste creating fuel from something normally just incinerated. (We have at least one of these going on line near Portland in the next six months). Farmers coops popping up throughout the mid-west to create a market for their crops when shipping or other costs make selling prohibitive. Also, specific nitrogen rich grasses and plant species grown as a rotation crop that offers the additional benefit of being sold as an ethanol feed source instead of just being plowed under.

Go to to learn more about ethanol as an alternative fuel. It seriously is a good deal all the way around.

I would also like to say that all we would need to do is alter the Clean Air act slightly to concentrate on CO2 over the other emmissions and magically we would have the same clean-diesel technology that Europe uses. 50mpg in a full size car or small SUV is common.

The Kitzhaber/Westlund (and now bandwagon jumper Kulogonski) "Oregon Appollo Project" is a bad deal. This your right about. But realize it for what it is. An attempt by democrats to make domestic energy a partisan football. Don't fall into their trap. Our side needs to address this energy issue straight up and head on.

As Dick Cheney said, "the American way of life is non-negotiable." But offering real choices for the market place to take a path is not compromising, its truly being American.

feigned sanity said...

I saw a comic in dilbert where the dog makes the point that oil is a fungible commodity. No matter if we buy the oil or not the money will still go to the people trying to kill us, so why not buy the cheapest oil as long as it doesn't matter if we buy from arab countries or not?

Dare, heres the problem with your tax, the arab countries, who are the cheapest sellers, say, "ok well since we can't import for the same price anymore, we're going to raise the price." The oil companies importing say "well since oil has limitless demand there's no way raising gas prices can hurt us" so they raise prices. It ends up coming out of the pocket of the American Citizens, just like every other tax. Ulitately hurting the American people rather than helping.

Dare!PDX said...

Feigned Sanity-

Your understanding of petroleum economics is a little suspect. First off these OPEC nations are forced to sell at world prices regardless of how low they are willing to sell. Even if they sell below market somewhere in between someone else will pick up the value difference.

Second, oil does have a limited demand. In 1995 oil bounced back between $8-$10 a barrel (this would be supply far ahead of demand). This led to financial issues throughout the dictatorships that contribute to OPEC and a rapid consolidation of major oil companies as they were running from bankruptcy. The world price for oil must stay above $15 a barrel in order to float the whole system.

Right now oil is floating between $60 and $75 a barrel. This premium of $45-$60 goes into the coffers of those who want us dead.

If American demand is significantly reduced it would go along way in reducing the fortunes amassed by those that would do us harm and prop up other like-minded dictators. There is alot of talk about Iran filling the void of the Soviet Union in the third world. This would not bode well for our free people anywhere. A $5 a barrel reduction is alot of AK-47 that Iran and Saudi Arabia don't buy.

Furthermore the sustainable technologies spawned would fuel our economy with efficiencies that other ecnonomies would be decades behind. This would go directly to productivity and a slowdown of the global warming contributing CO2 would be a dividend as well.

Efficient energy usage is no different than efficient processor power in computers or speed of communication and delivery. The money saved would also have the same economic stimulation as an increase in real wage. The time and money you save contributes all through our economy.

Dare!PDX said...

I just reread this post. 1995 had low prices but 1998 was the year that oil prices really bottomed out. (Arco and BP merged, Chevron bought Texaco, and Phillips 66 began to gobble up every BKing underperformer out there). Sorry