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.