Thursday, June 26, 2008

Energy Policy: Fred Thompson, Guest Blogger

Once again, The Oregon Economics Blog welcomes Fred Thompson writing about something I have been thinking of writing about for a while - energy policy.  Hopefully, if I can find the time, I will share some thoughts as well.  Here's Fred:
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A friend and former boss, who is also now a serious mover and shaker
the energy biz, recently privately opined:

"This country has had no energy policy for almost three decades.
Both parties are equally culpable for a situation that places our
economy in peril for many years to come. My answer for a
comprehensive energy policy:

1. Incentives and requirements for bio-fuels and alternative energy
sources now.

2. Revitalizing our nuclear energy program, ala France.

3. Opening up off-shore and ANWR drilling. (I am not convinced that
the shale program is feasible.)

4. Immediate construction of refinery capacity.

5. Immediate regulation of hedge fund investing in commodities that
have driven prices up for all commodities with no economically
productive purpose. (I don't completely buy into the argument that
these markets provide stability required by the refiners.)

There is no silver bullet, no single answer. Also, no short-term
solution. We are going to be in the energy soup for several years.
But we can find a way out of this mess with boldness and patience."

I have been hesitant to weigh in on this topic. I don’t have any
professional competence in the area of energy policy. However, these
are my thoughts.

It is true that last time (perhaps the only time) we had an energy
policy was during the Carter administration – remember the moral
equivalent of war? Those of you who are old enough will. The results
were not pretty.

The reason for current high energy prices mostly goes to supply and
demand for oil – energy prices are up because of booming demand for
oil from China, India and the Middle East and supply shortfalls in
the US, Mexico, Venezuela, Nigeria, Iran and Russia, not to say
Iraq. Moreover, while there are many substitutes for oil and gas,
few if any are cheaper, instead high oil and gas prices have merely
raised the prices of those alternatives. As my friend correctly
opines: “There is no silver bullet, no single answer. Also, no
short term solution.”

So, what about his proposals:

1. Incentives and requirements for bio-fuels and alternative energy
sources now.

I agree, we don’t do enough to promote energy conservation.
Moreover, what we do – direct regulation, for the most part, e.g.
the CAFE standards – is pretty inefficient. Most of our conservation
promotion programs seem ill designed from a behavioral standpoint.
On the other hand, we probably have sufficient incentives for the
production of wind and solar power right now, although only recently
have folks started to engage in serious genetic engineering to
reconfigure biological processes to generate increased energy from
solar power. Those programs should be accelerated, but it is
unlikely they will have a substantial payoff any time soon. In the
short run, it looks like Brazil has the capacity to increase sugar
cane ethanol production. Most developed countries won’t import it,
the US included. That is simply foolish. But I see no sense in the
multibillion-dollar government subsidies for domestic ethanol. Why
are higher food prices better than higher energy prices?

2. Revitalizing our nuclear energy program, ala France.

Absolutely. The French use half the oil per-capita we do. Nuclear
technology has advanced considerably in the last 30 years. It is
safer and cheaper. The lack of trained nuclear engineers is a
serious bottleneck, however.

3. Opening up off-shore and ANWR drilling. (I am less convinced
that the shale program is feasible.)

Makes sense to me. Again we know a lot more about off-shore drilling
now than we did when the Santa Barbara spill occurred. Listening to
the folks who are opposed, their main objection is to the
consumption of oil, not the danger to the environment from drilling.
I doubt that that argument has political legs. In the short run, I
agree with Nick about the shale program. One reason the tar sands in
Alberta work now and oil shale doesn’t is that the Canadians have
plenty of water in the right places. However, I have heard some
ideas about nuclear power/oil shale cogeneration that might solve
some of these problems, although this is certainly not a quick fix.

4. Immediate construction of refinery capacity.

Duh. Same goes for oil and gas pipelines and LNG terminals – some
environmentalists may not to see it, but these are primarily
conservation measures. Unfortunately, immediate construction in this
instance is something of an oxy-moron.

5. Immediate regulation of hedge fund investing in commodities that
have driven prices up for all commodities with no economically
productive purpose. (I don't completely buy into the argument that
these markets provide stability.)

I disagree. Hedging produces significant benefits for the risk
averse. Moreover, I don’t see how that options and futures trading
can distort spot prices without physical hoarding. Show me the
inventories and I'll reconsider the point. I would also note that
futures markets are different from carry-trade speculation
(borrowing at low interest rates to invest at higher rates).
Carry-trade speculation is dangerous, because you are betting
against the law of one price (uncovered interest-rate parity), in
other words, betting on your ability to time the market – when the
market turns, the herd stampedes. Moreover, in commodity trading
there is a counter position for every long position and, while you
can buy on the margin, you must mark to margin every day.

My big disagreement is with a point that is only implicit in my
friend’s comments. I want energy to carry a high price. That is the
best way I know to promote energy conservation and abate greenhouse
gases. Moreover, people will make the necessary investments in
plant, equipment, and lifestyle changes required to reduce energy
consumption substantially only if they expect energy prices to
remain high. Since there is but one thing more certain than taxes, I
think a high carbon tax is a great idea. Besides I’d rather the IRS
collected the rent than the Saudis, Russians, Nigerians,
Venezuelans, or even the Canadians. One could use the revenues to
offset social security and medi-care taxes on say the first $50k
(real $) of earned income as suggested by Irwin Seltzer, for
example. Actually, I think that is a marvelous idea for all sorts of
reasons. But that is a different story.

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