"But the gun is still loaded"

by: Lowell

Mon Feb 02, 2009 at 12:13:20 PM EST

A basic law of economics is that demand for any good or service is inversely related to that good or service's price.  The higher the price, ceteris parabis, the less people consume of it.  Likewise, the lower the price, the more people consume of it.  In the short run, the "price elasticity of demand" tends to be small, but in the longer run, it gets a lot higher.  In other words, if oil prices stay low for a while, and/or if people BELIEVE they will stay low for a while, demand for oil will start to rise.  Meanwhile, there's also an income elasticity of demand, whereby the lower one's income is, the less one consumes of goods and services.  Currently, we're seeing that in spades with the world economic slowdown, including demand for oil.  The question, once again, is how long will this last?

Obviously, we will not be in a recession forever.  Eventually - the question is really whether it's "sooner" or "later" - the economy will bounce back, as will demand for oil and other goods.  As demand for oil starts to grow again, the price almost certainly will rise, potentially putting us right back where we started in this particular "shock to trance" cycle (as Barack Obama calls it).  Here's Obama on the subject:

...this has been our pattern. We go from shock to trance. You know, oil prices go up, gas prices at the pump go up, everybody goes into a flurry of activity. And then the prices go back down and suddenly we act like it's not important, and we start, you know, filling up our S.U.V.'s again. And, as a consequence, we never make any progress. It's part of the addiction, all right. That has to be broken. Now is the time to break it.

What's the solution to "shock to trance?"  One possibility would be for the government to slap a steep tax on oil, fossil fuels, or carbon. Any of those measures would raise the price of oil, lower its demand, provide predictability to consumers and producers alike. Given the political difficulties in passing tax increases, another option is instituting a "cap and trade" system with regard to carbon. This would have the effect of indirectly raising fossil fuel prices.  Since the tax is indirect, people - so the theory goes - wouldn't notice it as much and it's more politically feasible.  Still difficult, though.  Another option is for the government to set stringent fuel economy standards for vehicles, which would not raise oil prices but would at least have the effect of cutting oil demand (or at least demand growth). Finally, the government could invest heavily in energy efficiency and/or renewables, or work in some other way to jumpstart the private sector in that direction.  Again, that wouldn't lower oil prices, but it would probably cut oil demand (or at least oil demand growth).

What if the government doesn't act at all and simply lets the "market" work its wonders?  Back to the Reuters article:

...while the economics of alternative energy projects may be depressed by the drop in oil, lower crude prices will not last forever.

Crude demand -- and prices -- are expected to pick up once the economy starts to rebound.

"It's bad now because prices are low but I don't think there's a forecaster who doesn't think prices are going to go back up," said Sarah Emerson, director of Energy Security Analysis Inc (ESAI). "By the time all of this is implemented prices will be back up at $60 or $80 anyway."

[...]

"All the lower prices have done is take the loaded gun away from our temples and place it on the table in front of us. But the gun is still loaded."

In other words, we can just wait until demand recovers - whether it takes a year, 5 years, whatever - and then watch oil prices rise again, at which point energy efficiency and renewable energy become more economical once again. From an environmental perspective, this is not acceptable at all. The problem is, simply, that we don't have time for this; the polar ice caps are melting now, the planet is on the verge of climate catastrophe now, the economy is being harmed now, our national security is being compromised now.  Which is exactly why we need the government to take strong action now, preferably with a robust combination of the options listed above, to correct this clear case of "market failure." If not, the results likely will be a continuation of the counterproductive "shock to trance" cycle we've been in for decades, a continuation of economic and environmental problems related to our wasteful energy consumption patterns, and a gun that is still loaded.  Who in their right mind would want THAT?  Right, I didn't think so.