In consequence, the Fed pushed down on the monetary accelerator. By July 2003 the Fed funds rate had been squeezed down to 1%, where it stayed for a year. This artificially low interest rate set off the mother of all liquidity cycles. Artificially low interest rates encouraged investors to take undue risks, chasing the slightest available yields. To make the most of tiny yields, leverage became the flavor of the day.

Carry trades — borrowing in low-yield currencies, such as the dollar, and investing in higher-yield ones — also became popular. Borrow, borrow, borrow. The resulting mountain of debt had to collapse, and it did. From mid-July 2008 until the end of November 2008, the dollar switched course, surging against the euro with a 28% appreciation. It was during this period that the asset bubbles created earlier started to pop. In consequence, the demand for dollars soared as carry trades were unwound and investors scrambled to find shelter from the storm.

As the skies began to clear in December 2008, the dollar reversed course again. Indeed, in the December 2008-June 2009 period, the greenback lost 11% against the euro. The volatile dollar has resulted, among other things, in a wild roller-coaster ride for commodity prices.

The dollar-commodity price linkage exists because most commodities are priced and invoiced in dollars. In consequence, even if a commodity's supply and demand fundamentals don't budge, the nominal price of a commodity will change as the value of the dollar changes. If the dollar's value sinks, the nominal price of a commodity will rise and vice versa.

The accompanying chart traces the movements in the dollar-euro rate and the path taken by the Commodity Research Bureau's index of 22 commodities. As the dollar lost ground, commodity prices took off. Indeed, the weak dollar accounted for the bulk of the commodity price increases during the great commodity bull market which ended in July 2008.

Thin dotted line: USD/Euro (left axis)
Thick solid line: CRB all US commodities Spot Index (right axis)

Contribution to oil price

For example, crude oil traded on the spot market at $19.84 per barrel on 28 December 2001. Adjusted for the change in the value of the dollar, assuming no changes in crude oil fundamentals, the nominal price of crude oil would have been $81.45 per barrel on 11 July 2008. In fact, the price on 11 July 2008 was $145.66 per barrel.

Therefore, the drop in the value of the dollar contributed 51% of the price increase from the end of 2001 to mid-July 2008 and positive fundamentals (changes in supply and demand) contributed 49% of the increase in crude oil price.

The volatile dollar, which serves as the world's premier currency (see accompanying chart), has opened the door for complaints. For one thing, commodity producers and consumers don't like the unstable commodity prices that accompany a volatile dollar.

It's no surprise that both Russia and China have raised the specter of replacing the dollar as the world's reserve currency. Moscow and Beijing have suggested using the International Monetary Fund's Special Drawing Rights (SDR) instead of the greenback.

The SDR was created in 1969. At present, it is an artificial metric which consists of 0.6 US dollars, 0.4 euros, 18.4 yen and 0.09 British pounds. Its value fluctuates with exchange rates. Today, one SDR is equal to 1.54 US dollars. The SDR is not a tangible medium of exchange or a claim on one. It's simply an accounting metric the IMF uses to balance its books. It has no real commercial application.

This led the Brazilian economist Prof. Alexandre Kafka, who served as an executive director of the IMF for over three decades, to lament that the IMF's "basket currency" had become a "basket case." Until a few months ago, it appeared that a 40-year experiment had ended in failure. Or has it?

While the dollar is not going to be displaced by the SDR as the world's reserve currency anytime soon, the stars seem to be aligned for a full-blown debate about the SDR's future role. Perhaps another chapter in the long-running SDR saga is about to open. As a precursor, the April 2009 Group of Twenty meeting in London concluded with a pledge to increase the IMF's SDR allocation by $250 billion. That is almost an eight-fold increase over the current stock of $32 billion.

In addition, the Russian bear is showing its teeth and China is gaining ground in the economic power game (see accompanying table). Both are beating the drums for wider use of the SDR.

Share of World GDP (%)

And that's not all. The current IMF managing director is Dominique Strauss-Kahn, a French socialist and a strong SDR advocate. Interestingly, the last time the SDR received a big boost was in the late 1970s, when the IMF's managing director was the distinguished Frenchman Jacques de Larosière.

Dollar hegemony has never been a Paris favorite. With Moscow and Beijing joining in, the SDR promises to become a favorite topic of the chattering classes, if not more.

One problem with this blame-game is that last year's recession was much deeper in many European and Asian countries than it was in the United States.

By the fourth quarter of 2008, as the nearby table shows, real US gross domestic product was just 0.8 percent smaller than it had been a year earlier. The contraction was twice as deep in Germany and Britain and much worse in Japan and Sweden.

In February, US industrial production was 11.8 percent lower than a year before -- while Singapore was down by 22.4 percent, Sweden by 22.9 percent and Japan by 38.4 percent.

What was the mechanism by which US problems were supposedly spread to other countries? It wasn't international trade. The dollar value of US imports didn't start to fall until August 2008, and imports of consumer goods didn't fall until September -- many months after Japan and Europe fell into recession.

Indeed, most of the economies that fell first and fastest were not heavily dependent on exports to the United States. Even Japan accounted for just 6.6 percent of US merchandise imports last year, compared with 15.9 percent for both Canada and China -- whose economies fared relatively well.

Even if all of the weakest European and Asian economies could plausibly blame all their troubles on the relatively stronger US economy, how could anyone possibly blame banks? There were no bank failures last year in Japan, Sweden, Canada or any other country on this list except Britain. And US and British banks didn't fail until September-October -- at least nine months after the Japanese and European recessions began.

Yet it's clearly US/UK banks being fingered as the villains. German Finance Minister Peer Steinbrueck, for example, criticized an "Anglo-Saxon" attitude in America and Britain that encouraged risky lending and investment practices because of "an exaggerated fixation on returns."

But Germany's GDP and industrial production was down 19.2 percent for the year ending in January -- versus an 11.4 percent decline in Britain and a similar US drop. Are we supposed to believe that German (and Japanese) firms are more dependent on US and UK banks than American and British firms?

Another problem with blaming the United States is that the timing is all wrong. If the US recession had simply spread to other countries like a mysterious infection, shouldn't the US economy have been the first to start contracting?

Yet US industrial production only started to decline from its peak after January 2008 -- long after production began to slow in Canada (July 2007), Italy (August 2007), France (October 2007) and the Euro area as a whole (November 2007). Aside from a one-month uptick in February 2008, Japan's industrial production peaked in October 2007.

By January 2008, when both the US and European recessions are said to have begun, the OECD leading indicators were lower by nearly 0.8 points from a year before in the US -- but down 2.3 points in Sweden, 2.8 points in Japan, 2.6 points in Korea and 4.1 points in Ireland.

Those leading indicators correctly anticipated much deeper recessions in the latter four countries. And the most famous leading indicator -- monthly stock prices -- peaked in October 2007 in the US and UK, four months after stocks had peaked in Japan and the Euro area.

What did all the contracting economies have in common? Not all had housing booms -- certainly not Canada, Japan, Sweden or the other countries at the bottom of the economic-growth list.

What really triggered this recession should be obvious, since the same thing happened before every other postwar US recession save one (1960).

In 1983, economist James Hamilton of the University of California at San Diego showed that "all but one of the US recessions since World War Two have been preceded, typically with a lag of around three-fourths of a year, by a dramatic increase in the price of crude petroleum." The years 1946 to 2007 saw 10 dramatic spikes in the price of oil -- each of which was soon followed by recession.

In The Financial Times on Jan. 3, 2008, I therefore suggested, "The US economy is likely to slip into recession because of higher energy costs alone, regardless of what the Fed does."

In a new paper at cato.org, "Financial Crisis and Public Policy," Jagadeesh Gokhale notes that the prolonged decline in exurban housing construction that began in early 2006 was a logical response to rising prices of oil and gasoline at that time. So was the equally prolonged decline in sales of gas-guzzling vehicles. And the US/UK financial crises in the fall of 2008 were likewise as much a consequence of recession as the cause: Recessions turn good loans into bad.

The recession began in late 2007 or early 2008 in many countries, with the United States one of the least affected. Countries with the deepest recessions have no believable connection to US housing or banking problems.

The truth is much simpler: There is no way the oil-importing economies could have kept humming along with oil prices of $100 a barrel, much less $145. Like nearly every other recession of the postwar period, this one was triggered by a literally unbearable increase in the price of oil.

In addition, with the U.S. Federal Reserve System greatly expanding the money supply - which will continue because of the explosion in government spending - the dollar is falling against other currencies; and given that global oil is priced in dollars, the price of oil will rise in dollar terms, just as it did two years ago.

About 65 percent of the demand for global oil can be supplied at a price of $35 per barrel. Another 20 percent of demand can be supplied at a price of $35 to $60 per barrel, but the remaining 15 percent will only be supplied over the long run at prices of $60 to perhaps $130 per barrel. Oil, like all commodities, is priced at the margin, which means the price of all oil demanded by the market is equal to the price that producers can get for the last barrel of oil they sell.

It takes considerable time to greatly increase oil production, and it also takes time to reduce production. Despite the global recession, oil production capacity is only slightly above demand, so that any significant supply disruption - a war in an oil-producing area, pipelines being blown up or tankers sunk, etc. - will almost immediately create a supply shock, causing the oil price to soar again.

Because of the drop in oil prices during the last eight months, high-cost production facilities are being shut down, including low-output wells, some offshore production, Canadian oil sands, etc. When the oil price shoots back up, it will take time to get these production facilities back on line.

Oil prices will almost certainly be much higher in real terms (inflation adjusted) during the next 15 years because world energy demand is expected to increase at an average annual rate of 1.6 percent between now and 2030. More than 80 percent of the increase in energy demand during the next two decades is expected to come from China, India and the Middle East.

Low-cost oil production is declining sharply, as the old easy-to-produce fields are being rapidly depleted. There are still huge potential oil supplies, but most of it will be in very expensive, deep-sea areas, or in oil sands (Canada) or oil shale (Colorado, Wyoming, Utah), all of which are much more costly to produce. Biofuels are also expensive and compete with food for land on which to produce them.

If suddenly it were announced that a miracle electric battery - one that could power a full-sized automobile at high speed for more than 300 miles and could be quickly recharged - had been developed, what impact do you think it would have on the price of gasoline next week? The answer is probably none because it would take several years for the manufacturers of automobiles to switch over completely to battery-powered ones, and then another decade or so before most of the existing stock of automobiles would be battery powered.

In the long run, improved battery technology will probably reduce the demand for liquid fossil fuels, but even under the most optimistic scenario, the dependence on oil will last a couple or more decades.

As vehicles eventually move from liquid fossil fuels to electricity, the demand for liquid petroleum will drop, but the demand for electricity will greatly increase. The environmentalists and many in the political class like to talk about "renewables" meeting the demand. A nice notion, but at best it is not going to happen for decades. As the chart shows, wind, solar and geothermal are less than 3 percent of total energy supply. They all still need to be heavily subsidized because they are not economical and probably will not be for many years.

Hence, even at high-growth rates, they will only supply a small percentage of total energy needs in the next two decades.

When oil prices soared a couple of years ago, the Bush administration moved to open up government lands and certain offshore areas for more oil exploration and production. Officials in the new Obama administration are now in the process of again locking up these areas to prevent oil production.

If the Obama administration is right in its forecast that the economy will be growing again by the end of this year - which is probably even more true for the world economy - the demand for oil will be rising rapidly again. Yet much production has been shut down because of the recession, and potential future supply inside the U.S. is being restricted by government action.

The result should be obvious - gasoline at the pump will be at least $3, if not $4 or more. Americans will still be hurting as a result of the recession, so many of them will be most unhappy to see the prices soar again.

Given that many in the political class seem to think the long run is the next five minutes, they do not see or want to see this tsunami coming. Many politicos will try to blame the high prices on "greedy oil companies" or laggard automobile executives rather than to look in the mirror and see the shortsighted demagogues whose policies led to the mess.

Several Cato Institute studies have called for privatization of the public lands, but this idea is strongly resisted by environmentalists, recreationists, and other users of public land. An alternative policy that will both enhance the values sought by environmentalists and improve the fiscal management of the lands is to turn them into fiduciary trusts. Under this proposal, the U.S. would retain title to the lands, but the rules under which they would be governed would be very different.

Fiduciary trusts are based on hundreds of years of British and American common law that ensures that trustees preserve and protect the value of the resources they manage, keep them productive, and disclose the full costs and benefits of their management. For trust law to apply, public land trusts must be based on a law written by Congress that clearly defines the trustees, the beneficiaries, and a specific mission or missions for the trusts.

Congress should create two types of trusts. Market trusts would have a mission of maximizing revenue while preserving the productive capacity of the land. To achieve this mission, Congress should allow them to charge fair market value for all resources. Nonmarket trusts would have a mission of maximizing the preservation and, as appropriate, restoration of natural ecosystems and cultural resources on the public lands.

Each pair of market and nonmarket trusts would jointly manage all federal lands in one of about a hundred ecoregions. Each ecoregion would have about 5 to 10 million acres of federal land that might include forests, parks, refuges, and other public lands. Trustees would be elected by a friends' association that anyone would be welcome to join. Trusts would be funded out of the user fees they collect, with some retained by the market trust and some given to the nonmarket trust. In some cases, excess user fees would be returned to the U.S. Treasury.

The trust idea would significantly improve both fiscal and environmental management of the public lands. Congress should begin to implement this idea by testing it on selected national forests, parks, and other federal lands.

Before trying one more time, legislators should ask why they favor a policy so politically correct and so economically suspect. Support for a national program largely stems from misleading claims about state-level successes, misunderstandings about how renewables interact with other environmental regulation, and misinformation about the actual benefits renewables create.

State RPS programs are largely in disarray, and even the apparently successful ones have had little impact. California's supposedly aggressive program has left it with the same percentage of renewable power as in 1998, and Texas's seemingly impressive wind turbine investments produce only two percent of its electricity. The public may envision solar collectors but wind accounts for almost all of the growth in renewable power, and it largely survives on favorable tax treatment. Wind's intermittency reduces its efficacy in carbon control because it requires extra conventional generation reserves. Computer-generated predictions about a national RPS are generally unreliable, but they show that with or without one the great majority of generation investments for the next several decades will be fossil-fueled.

Even without the technological and environmental shortcomings of renewables, the case for a national RPS is economically flawed. Emissions policies are moving toward efficient market-based trading systems and more rational setting of standards. A national RPS clashes with principles of efficient environmental policy because it is a technological requirement that applies to a single industry. Arguments that a national RPS will create jobs, mitigate energy price risks, improve national security and make the United Sates more competitive internationally are in the main restatements of elementary economic fallacies. It is hard to imagine a program that delivers as little in theory as a national RPS, and the experiences of the states indicate that it delivers equally little in practice.

The "New Energy Reform Act of 2008" (The "New Era" Act, get it?) would allow for more domestic drilling ... sort of. While "Drill Now!" Republicans have called for opening up all federal waters for oil and gas development currently off limits to the industry " subject to coastal-state approval " the Senate bill would do the same with the exception of the Pacific Coast, which would remain off-limits.

Now, that probably doesn't make much difference. California, Washington, and Oregon would likely have blocked drilling off their coasts under the Republican plan anyway. But if minds should change there and those respective state legislatures were willing to allow drilling to go forward, why should the feds say "no"?

Even so, the Senate bill loads some important conditions and caveats onto any prospective off-shore drilling activity. For instance, it would impose and an environmental buffer zone extending 50 miles offshore where new oil and gas production will not be allowed. It's unclear how much oil would remain locked away under this provision because many of those areas have not been thoroughly explored, but why preemptively take that oil off the table?

Moreover, the bill requires all new production to be used domestically, a provision that is easy to sell to the public but not so easy to sell to economists. Whether that new crude is exported or not, oil and gasoline prices around the world cannot vary by more than the transportation costs from one place to another. If a producer can get a higher price elsewhere, prohibiting him from getting that higher price simply reduces the profits available - and thus the investment dollars available - to domestic producers over the long run. Hence, if it has any price impact at all, the "no exports" provision would increase rather than decrease price.

What will all this mean for oil prices? Nothing of consequence. If the Energy Information Administration (EIA) - the analytic arm of the U.S. Department of Energy - is correct about the reserves at issue, it would mean the ultimate infusion of no more than 8 billion barrels of oil into the market at a rate no higher than about 100,000 barrels per day. If that oil were being produced today (and EIA estimates that it would take ten years for that crude oil to come fully on line), it would represent, at best, a 1/10th of 1 percent increase in global supply and, ultimately, about a 1/5th of 1 percent reduction in crude oil prices. Throw the Pacific coastal reserves into the mix and you can double those figures.

While EIA's estimates are highly speculative (we can't know how much economically recoverable oil there might be in areas we haven't explored) it does tell us that, to the extent we have clues about these things, we're probably not talking about turning the United States into Saudi Arabia. Republican promises that drilling offers a quick and sure-fire way to reduce gasoline prices are almost certainly fraudulent.

The handouts the Senate bill would send Detroit's way suggests that the auto companies have taken over the federal government. $7.5 billion of taxpayer money is promised to auto companies engaged in research and development (R&D) of alternative fueled vehicles. Another $7.5 billion is promised for retooling production facilities to make those vehicles. $500 million is pledged to underwrite R&D to enhance automotive fuel efficiency. And those are just the highlights.

It should go without saying, of course, that if those are worthwhile investments, they should and would be made by corporate stockholders, not U.S. taxpayers.

To help guarantee auto sales, the feds will offer a $7,500 tax credit for buying vehicles that run primarily on something other than gasoline, a $2,500 tax credit for retooling existing engines to do the same, $2,500 tax credit for buying super fuel-efficient vehicles, and extend the existing $2,500 tax credit for buying hybrid-electric vehicles.

Of course, car buyers already have plenty of incentive to buy fuel-efficient cars. Lots of money will thus be spent to provide handouts for the purchase of vehicles that would have been purchased anyway. And it's a regressive handout at that. Poor people are less likely to be in the market for new cars than wealthier people. Finally, it sets up what economists call a "moral hazard." That is, it rewards - not those who jumped to replace the gas guzzler with a gas sipper - but those who've resisted doing so up until now. The message? In the future, don't conserve on your own; wait for the government to pay you to conserve.

Energy producers also win big ... as if they weren't winning big in the market already. The most obnoxious - and thus, most popular - provision is the extension of a renewable fuels production tax credit that is the thin blue line between profits for investors like T. Boone Pickens and billions of dollars of losses for the same. If renewable energy companies can't compete after years on the dole and record high energy prices, when can they?

But there's more. $2.5 billion is dedicated to R&D to produce "next generation" biofuels and infrastructure. Hundreds of millions more are spent on tax incentives for a new fuel delivery infrastructure, new transmission lines to get renewable energy to end-users, and oil producers who are injecting CO2 (a greenhouse gas) into fields to improve recovery rates - something that has gone on and will continue to go on whether there is a tax credit or not. Tax dollars are also used to provide grants and guarantee loans to investors building coal-to-liquid facilities with carbon capture capability. Nuclear-power plant owners get favorable accelerated depreciation tax schedules.

Question: If energy companies are making such stunning profits, why does the taxpayer need to underwrite their investments? Another question: If these targeted technologies are so promising, why won't profit-hungry investors put their own money on the line? If they won't, what does Congressman Vote Crazy know that analysts at Goldman Sachs do not? If they will, then isn't private capital just as good as public capital?

The total cost of these handouts amounts to a cool $84 billion. Most of it will simply be borrowed from foreign lenders. $30 billion, however, will come from a 14 percent "severance tax" on oil production in the Gulf of Mexico and from the elimination of tax breaks afforded to the oil and gas industry under Section 199 of the tax code, which provides for tax breaks to all U.S. manufacturers.

While one can make a good argument for repealing Section 199 in toto - the feds have no business rigging the market to make investments in manufacturing more attractive than investments in something else - targeting the oil and gas companies makes no sense. Morgan Stanley reports that the exploration and development tax rates on "Big Oil" average about 45 percent - substantially higher than the tax rates paid by other U.S. industries. Hence, cutting the taxes paid by oil and gas companies - not increasing them - would make better policy. Alas, it probably would not make better politics.

People who believe that the government should make all decisions about what kind of energy is produced, how that energy is used, and how much energy is consumed will of course be thrilled with a bill like this (unless, of course, their favorite fuel is left without a large and expansive spot at the federal trough). People who doubt the government's ability to run whole industrial sectors, on the other hand, should be horrified at this advertised "New Era" energy bill.

Unfortunately, Washington is now almost entirely made up of the former, not the latter, so the only real debate we're likely to get pertains to the provisions surrounding off-shore oil drilling and whether to tax - or borrow - the money necessary for this mountain of corporate welfare. That's too bad, because even if the bill gave Republicans everything they wanted on those issues, it would still constitute a rebuke to everything Republicans tell us they believe in. Or once told us they believed in.

Where are prices going next? Who knows? Bearish talk about bubbles bursting and bullish talk about peak oil disguise the fact that the future direction of oil prices is unknown and unknowable. Neither investors nor politicians ought to be betting the economic house on any particular vision of "our energy future."

The fundamental reason for the difficulty associated with forecasting future oil prices is the fact that both demand and supply are relatively inelastic over the short term. That means rather small changes in either can have very large price effects. Hence, those who wish to forecast oil prices are forced to forecast weather patterns, labor relations, gross domestic product (GDP) reports, demographic trends, civil unrest and technological change in all sorts of disparate economic sectors.

Long-run forecasts are no easier to execute. Professor Vaclav Smil of the University of Manitoba has cataloged the vast record of energy forecasts offered by academics, corporations, consultants, trade associations, government agencies, "blue ribbon" commissions, policy activists and "futurists" of all stripes over the past 100 years and finds a "a manifest record of failure." There is simply no reason to believe that mere mortals can foretell oil prices or petroleum market shares in the future, absent some sort of time machine.

A recent analysis of world crude oil prices by Professor James Hamilton of the University of California at San Diego reinforces Smil's point. In a paper published by the University of California Energy Institute, Hamilton looked at data from the first quarter of 1970 through the first quarter of 2008 and asked the question, "How predictable statistically is the change in the real price of oil over this period?" It turns out that:

• Neither nominal U.S. interest rates nor real U.S. GDP growth rates can predict oil price movements.
• Although prices increased by 172% (logarithmically) over the sample period (an average of 1.12% per quarter), Hamilton could not reject the null hypothesis that there was no trend in the data.
• The data is most consistent with the observation that oil prices move akin to "a random walk without drift."
• The best predictor of future oil prices is the present oil price.

If the best predictor of future prices is present price, how then do we account for the extreme volatility in the record? Simple: Present price may be the best predictor, but it is a lousy predictor nonetheless. Hamilton finds that the standard deviation in oil prices from quarter-to-quarter was 15.28%. Hence, if we start a quarter with $115 oil, prices in the next quarter could average between $85 and $156 per barrel. In a year, they could range between $62 and $212. In four years, they might be anywhere between $34 and $391!

Of course, if oil prices were to rise — or decline — to the upper or lower boundary of our "random walk," market analysts and policy pundits would likely wet their pants over "the end of the oil age" (in the case of the former) or the end of OPEC (in the case of the latter). While trends in those cases would be perfectly consistent with either narrative, they would also be perfectly consistent with a random walk ... and no real trend.

There is an insatiable market demand for oil price forecasts and an equally insatiable political demand for mega-explanations about oil prices. But unless the oil market changes pretty radically, neither demand can be met by well-informed oil market analysts.

Local food is often better-tasting and more nutritious. That's a pretty good reason to pay more for it. Maybe you want to support small local farms. Go ahead, if that's your bag. But don't think going local does much to reduce your carbon footprint. And it shouldn't do much to ease your conscience.

How far your food travels matters a lot less than what kind of food it is, or how it was produced. According to a recent study out of Carnegie Mellon University, the distance traveled by the average American's dinner rose about 25 percent from 1997 to 2004, due to increasing global trade. But carbon emissions from food transport only saw a 5 percent bump, thanks to the efficiencies of vast cargo container ships.

A tomato raised in a heated greenhouse next door can be more carbon-intensive than one shipped halfway across the globe. And cows spew a lot more greenhouse gas than hens, or kumquats, so eating just a bit less beef can do more carbon-wise than going completely local. It's complicated.

But one thing is clear enough: the farmers in Mexico, China, and Brazil, who produce a lot of the imported food Americans eat, are poorer than the farmers here in Iowa. A lot poorer. The corollary of "eat local" is "don't eat Mexican," so to speak. But the way poor people get less poor is to do business with people who have a lot of money, like us. If the local stuff is mouthwatering, you might as well pony up. But if your salad is made with Mexican lettuce, savor your righteousness.

Will Wilkinson discusses the “eat local” movement on Marketplace Radio (August 27, 2008) [MP3]

The U.S. Energy Information Administration (EIA) — an analytic arm of the U.S. Department of Energy — reported last year that removing all offshore drilling restrictions would liberate about 18 billion barrels of petroleum at a rate of about 200,000 barrels a day. About 10 billion barrels of that oil, however, is thought to be off the California coast, which is important to keep in mind given John McCain's caveat that states should be allowed to say "no" to drilling in federal waters off their coasts.

If the EIA is right, then we're talking a trivial amount of new crude in global terms. Global oil production last year averaged about 86 million barrels per day. If global oil production were at that rate when this new 100,000 barrels of oil hit the market (roughly the EIA's estimate minus California), it would increase global supply by all of one-tenth of 1%. If the oil market reacts then as it has in the past when new supply hits the market, this would translate into reduction of one-fifth of 1% in world crude oil prices over the long term. Even if California were to allow drilling, we're still well short of even a 1% reduction in price.

But the EIA may not be right about the extent of the oil at issue.

First, the EIA determined what was technically recoverable in part by estimating how much of this new oil could be economically exploited were prices at $50 a barrel in 2005 dollars. If we assume that oil prices will be higher in the future, then what is "technically recoverable" will surely go up.

Second, most of the waters in question have never been thoroughly explored. How much economically recoverable crude oil is yet to be found in the 85% of U.S. coastal waters currently off limits to the industry is thus unknowable. We can guess, of course, but those guesses are based on very limited information.

But think twice before arguing that there's probably not enough undiscovered oil off shore to substantially reduce gasoline prices. Only monster fields cross that threshold, and if we eschewed drilling everywhere else, global oil production would only be a fraction of what it is today. Likewise, arguing against drilling because the oil will take a decade or more to come to market in significant volumes — which is likely correct — is an argument against acting today to head off problems tomorrow.

You might, of course, want to argue that the environmental risks are greater than the energy rewards. For the sake of argument, let's assume that the EIA is right and 18 billion barrels of oil are at stake. And let's further assume that the oil could be sold for an average price of $100 a barrel. How likely is it that the cost of the environmental damages associated with this incremental increase in oil production would exceed $1.8 trillion? If it did not, then the environmental risks were worth taking.

Some argue that the world is running out of low-cost oil and that oil prices will get higher and higher. Others argue that the current high price of oil will cause a flood of new oil, much of it from nonconventional sources; hence, prices will fall significantly (provided the political class in Washington, D.C., does not continue its energy and environmental death march policies).

The case for much lower oil prices is as follows. There are hundreds of years of oil supplies (at present and projected consumption levels) if oil in oil sands and shale is properly included in reserves. In some places, such as Saudi Arabia and Iraq, there is still much low-cost oil ($15 a barrel or even less) that can be produced for decades, but not in an amount sufficient to meet the world's demand; hence, much higher-cost oil is also pumped. This higher-cost oil includes much of the offshore oil (the huge cost of the mammoth drilling rigs has to be amortized over each barrel of oil produced) and on-shore oil in hard-to-reach places and/or produced from low-production wells.

Oil reserves are largely a function of price. Global proven reserves of conventional oil obtainable at prices of less than $40 per barrel are estimated at more than 1.3 trillion barrels, with much of it concentrated in the Middle East. Additionally, reserves of so called "heavy oil," the largest reserves of which are in Venezuela's Orinoco area, are estimated at 1.2 trillion barrels, and most of this could probably be recovered for less than $50 per barrel.

The reserves of oil sands, which are actively being mined in Canada's Alberta Province, are estimated to be 1.8 trillion barrels. Experts estimate that much of this can be produced for $45 per barrel or less. Global reserves of oil shale are estimated at more than 3.3 trillion barrels, with 70 percent in the United States (primarily in Colorado, Utah and Wyoming).

Shell Oil Co. last year announced it has developed a process for extracting the oil from the shale, without mining, at a price of roughly $35 per barrel. The United States also has the world's largest reserves of coal — enough for hundreds of years of production at present levels. Coal also can be turned into liquid petroleum (as the Germans and South Africans proved decades ago). Current estimates of the conversion cost are as low as $35 per barrel.

Does it seem a bit odd that the current price of oil is more than twice the cost of producing all the oil the world presently needs and will need long into the future? The reason the price is so high is that the supply has been artificially constrained by governments. Most (88 percent) of the conventional oil reserves are owned by governments, and these governments have underinvested in new production. As is well-known, the U.S. government has restricted offshore and onshore drilling, shale development, and coal conversion.

Some politicians argue, even if the U.S. government started to allow increased production, that it would be seven to 10 years or more before there would be additional output. This is nonsense. Oil wells can be drilled at an average rate of 1,000 feet or so per day, which means that the average U.S. well can be drilled in a week. It does take a few weeks to set up the pump and install the separation tanks, etc., but new land wells can be producing within months, even if the product has to be trucked rather than piped away.

Drilling in the Arctic National Wildlife Refuge in Alaska would not take all that long for some production to get started. Politicians often confuse the time it takes to get peak production from a field as compared to some production — each additional well takes time, plus the necessary new piping collection infrastructure for each additional well.

Offshore wells do take a lot longer, but most of the time involved is the government permitting process, not the physical production of the rigs, drilling and so forth. If the government gave a full green light to production of oil shale in the Rocky Mountains, it might take several decades to reach full production, but some production would be accomplished in the next couple of years.

The very same politicians who claim we cannot increase oil production quickly are often the same ones who tell us we need to move to alternative forms — windmills and solar, etc. — without seeming to understand these desirable technologies will take far more time to meet the goals of "energy independence" than ramping up oil production. Speaker of the House Nancy Pelosi said she would not allow a vote on more drilling because she wanted "to save the planet," without seeming to understand, if increased oil production does not take place in the United States with all its environmental safeguards, it will take place where U.S. environmental law cannot be enforced — and that is not healthy for the planet.

Fortunately, the people are beginning to understand they are paying twice more for a gallon of gasoline than is necessary, and the global environment is not benefiting. Less expensive energy and a cleaner environment are most likely to be achieved quickly not with alternative energy sources but with an alternative set of congressional leaders.

On July 15, 1979, Pres. Jimmy Carter gave a televised address to the nation about America's "crisis of confidence" and how that crisis was feeding "a fundamental threat to American democracy" — reliance on imported oil. It was derided at the time as the "national malaise" speech (Carter never actually used the phrase), and according to legend it was the most politically disastrous speech ever given by a sitting president.

But rehabilitation is in the air. If only we had listened to Jimmy Carter back then, we are increasingly told, we wouldn't be in the energy mess we're in today.

Before we get too deep into this revisionist cup, it is worth looking closer at the policy road supposedly not taken. It turns out that much of what Carter proposed was subsequently adopted, and much of what wasn't was unnecessary.

The first thing President Carter promised was that, "beginning this moment, this nation will never use more foreign oil than we did in 1977 [3.2 billion barrels] — never. From now on, every new addition to our demand for energy will be met from our own production and our own conservation." Oil import volumes indeed stayed below 1977 levels for the next 16 years, but not because of any government policy: Soaring oil prices and a subsequent recession reduced demand for oil. This partially explains why Carter's second promise — to impose oil-import quotas to secure those import reductions — was both unnecessary and (thankfully) quickly forgotten.

But maybe in 1995, when foreign-oil consumption finally surpassed the 1977 benchmark, President Clinton should have imposed these quotas? No. Few remember that President Eisenhower slapped import quotas on oil back in 1959, and they remained in effect until President Nixon repealed them in 1973. According to oil economists Douglas Bohi and Milton Russell, the quotas forced domestic oil prices significantly above global market prices, enriching domestic oil producers at the expense of domestic consumers. Restricting imports forced U.S. fields to produce more crude than would otherwise have been the case (as a consequence, one might tag it a "drain America first" program).

President Carter's third promise was to unleash an avalanche of federal subsidies for synthetic fuels, oil-shale development, ethanol, "unconventional gas," and solar power, all of which were to be paid for by a windfall-profit tax. And Carter mostly got his way — for awhile.

The 1980 Energy Security Act established the Synthetic Fuels Corporation (SFC) to subsidize exotic fossil fuels. The act authorized expenditure of $17 billion, with a goal of bringing about production of 500,000 barrels of oil a day by 1987 and 2 million barrels a day by 1992. It promised another $68 billion once the SFC submitted a "comprehensive strategy" to meet the production targets.

But by the time the first $100 million — million, not billion — went out the door, all but two SFC projects were cancelled due to cost overruns and technical problems. Congress shut down the SFC in 1985.

Congress likewise gave Carter all of the solar and other renewable-energy subsidies he wanted. From fiscal years 1979 through 1981, in fact, Carter got more solar-energy subsidy dollars than he asked for. A residential tax credit was put in place for 40 percent of the first $10,000 spent on photovoltaic solar-energy systems. A business tax credit of 15 percent was granted through the end of 1985. A "Solar and Energy Conservation Bank" was established and authorized to spend $3 billion between fiscal years 1981 and 1984 to provide subsidized residential and commercial loans for solar energy and conservation investments.

Subsequent (Democratic) Congresses, however, cut those appropriations and tax credits back substantially. Would solar power have done better if they hadn't? While it's certainly true that the cost of producing solar-powered electricity fell dramatically during the 1980s, there is little evidence that federal subsidies had much to do with it.

President Carter even got the ethanol subsidies he wanted. Congress extended the federal excise-tax credits that were scheduled to expire and enacted a new tax credit of 30 to 40 cents per gallon for those who were not subject to the excise tax to begin with. It authorized $1.2 billion to promote conventional and cellulosic ethanol, with a goal of replacing 10 percent of gasoline consumption by 1990. These subsidies, however, proved incapable of making ethanol economically competitive with conventional gasoline. So did massive increases in those subsidies over the course of 29 years.

To pay for all of this, President Carter got the windfall-profit tax he wanted. But this too proved disappointing; before being abolished in 1988, the tax returned only $40 billion of the $175 billion projected. And analysts at the Congressional Research Service estimate that it reduced domestic oil production by 3 to 6 percent — thus driving up prices — and increased oil imports by 8 to 16 percent.

Most memorably, however, the president promised to employ both carrots and sticks to force conservation. "I'm asking you for your good and for your nation's security to take no unnecessary trips, to use carpools or public transportation whenever you can, to park your car one extra day per week, to obey the speed limit, and to set your thermostats to save fuel," Carter said in that speech. "Every act of energy conservation like this is more than just common sense — I tell you it is an act of patriotism."

The federal government, in fact, would make sure that you did your part. The president issued an executive order restricting indoor temperatures in non-residential buildings to 78 degrees or warmer in the summer and 65 degrees or cooler in the winter. The administration did little to monitor compliance, however, arguing that the program was "largely self-enforcing."

Carter promised to mandate a 50 percent reduction in the use of oil for electricity generation. And although the president failed to get his $10 billion coal-conversion plan through Congress, the amount of electricity generated from oil nevertheless declined from 3,283 trillion BTUs in 1979 to 715 trillion BTUs today. Once again, markets accomplished what politicians could not: As oil rose in price, it became more expensive than coal, so generator operators switched over without the government's forcing them to.

More arresting was President Carter's promise to institute gasoline rationing if Congress gave him the authority and he found it necessary. Congress gave him the authority, but he left office before finding it necessary. And it's a good thing: Only a few years earlier, Nixon had instituted gasoline rationing, and gasoline lines and shortages had promptly followed.

President Carter's most aggressive stab at conservation, however, involved the U.S. auto fleet. Carter initially suggested giving Detroit more flexibility to meet the mileage standards that had been adopted before he took office, and Congress obliged him in 1980. But in the final months of his administration, the National Highway Traffic Safety Administration proposed raising those standards for passenger vehicles to 48 miles per gallon by 1995. Just three months later, the Reagan administration rescinded the proposal.

While it's hard to envision what the auto fleet would look like today had that rule been adopted (no car currently for sale in America would meet Carter's standard), we can guess that the roads would be more congested, urban sprawl would be far worse, traffic fatalities would be higher, and ambient air pollution would be greater. Economist Andrew Kleit has explained why in detail. The short version: When people can drive more miles for each gallon of gas they buy, they tend to do just that.

Soaring domestic demand for oil did not cause the energy crisis of the 1970s, or today's. Neither did disruptions in the supply of oil. Rather, the 1970s price spiral was largely driven by inept monetary policy, whereas today's spike is the consequence of an unanticipated surge in global economic growth, as economist Lutz Kilian argues in a forthcoming paper for the Journal of Economic Literature. Hence, even had we embraced the Carter plan in toto, it would not have made the current price spiral less likely or less steep. For instance, a 48 mpg standard might have reduced global oil consumption from 85 million barrels a day (where it is at present) to 80 million barrels a day, but when there's less consumption, there's also less investment in production. Kilian's summary of the academic literature suggests that, in this hypothetical, 80 million-barrel-a-day world, the global economic surge of 2003 would have caused the exact same price explosion we see today.

At its most basic level, federal energy policy addresses two questions: Does the government know better than investors which technologies to invest in, and does the government know better than consumers how much energy they'll need? America's experience with Carter's suggestions demonstrates that the government has no advantage in either.

Imagine Pickens' surprise when he discovered that our environmental and economic salvation is to use subsidized wind power to replace the natural gas we now use to generate electricity, and then to use that freed-up natural gas to power our cars. We could use new wind power to replace dirty coal instead. But that's not the plan.

All commercials are trying to sell us something. But Pickens' ad isn't aimed at us the consumers, but at voters sadly under-informed and easily stirred by appeals to emotion. The Pickens Plan is not about offering you, the consumer, a choice.

If wind power were more efficient than the alternatives, we'd already be using more of it. If natural gas cars were attractive to consumers, we'd already be driving more of them. The Pickens plan is about getting the government to use its powers to tax, regulate, and subsidize -- and pick winners in the energy sector.

When Pickens says:

T. Boone Pickens: Over $700 billion are leaving this country to foreign nations every year.

and adds up to:

Pickens: It'll be the largest transfer of wealth in the history of mankind.

He's leaning hard on our worst nationalist impulses and attacking the very idea of peaceful, mutually beneficial trade. Listening to Pickens, you'd never know we got something for all that money. What he's really saying is: Why buy the things you need from dangerous foreigners when you could be buying them from rock-ribbed Americans, like T. Boone Pickens?

In the end, The Pickens' plan is that government use its powers to make Pickens the winner. Don't help him. The last time Pickens spent millions on political ads, the Swift Boat Veterans offered us, the voters, their version of the truth. How do you like how that turned out?

Will Wilkinson discusses T. Boone Pickens' energy plan on Marketplace (July 16, 2008) [MP3]

First, oil imports are not the cause of high gasoline prices. On the contrary, oil imports serve to keep gasoline prices down. After all, we import oil for a reason; it's cheaper than the domestic alternative. If we were to restrict our energy diet to energy produced in the United States, it would make domestic energy producers (like Mr. Pickens) far richer and energy consumers (the rest of us) far poorer, and GDP would be reduced as well. While one can understand why Mr. Pickens is attracted to the idea of "energy independence," for the rest of us, keeping the country open to imported goods is pro-consumer whether we're talking about oil, steel, textiles, or athletic shoes.

Second, we are no more forced to rely on the "good will" of foreign oil producers when we shop for petroleum than we are forced to rely on the "good will" of supermarkets when we shop for eggs and milk. Oil producers export crude oil because it's a great way to make money—and for many, the only way to make money. And once that oil is in the global marketplace, market actors, not oil producers, dictate where it goes. Hence, we are betting on producer greed ... which is a pretty safe bet.

Third, if wind energy were a sensible economic investment, it would not need the lavish federal and state subsidies already in place or the additional largesse sought after by Mr. Pickens. Likewise, if compressed natural gas (CNG) vehicles are an economically sensible alternative to conventional gasoline powered vehicles, then no government "master plan" is necessary to deliver them to market. Price signals will induce investors to invest and consumers to buy without government having to lift a finger. The same goes for all the other energy-related R&D Mr. Pickens would like the taxpayer to dole out. If that R&D is promising, it will be pursued whether government subsidizes it or not.

Fourth, if reducing our carbon footprint is the goal, then the most direct and efficient means of reducing that footprint is to impose a tax on carbon emissions and then leave it to the market to sort out how to most efficiently order affairs under those new prices. Maybe it will mean windmills and CNG, but maybe not. Perhaps it will mean more nuclear power, new hydrogen-powered fuel cells, "clean" coal, the emergence of cellulosic ethanol, battery-powered cars or hybrids—or a continuation of the existing energy base but less consumption as a consequence.

Of course, if the market were to go into any of those directions, Mr. Pickens would be out a lot of money, which is probably why Mr. Pickens wants to hard-wire the market to consume the things he's investing in and have the government lavish him with subsidies in the course of doing so. I wish Mr. Pickens well in the course of his wind energy business, but I see no reason why taxpayers, ratepayers, or consumers ought to be forced to sacrifice in order to fatten his already ample bank account.

Many members of Congress make up "solutions" to things they do not understand and cause problems where there are none or make real problems worse, which explains the current run-up in gasoline prices. There are "futures" markets in most basic agricultural, metals and energy products. In a futures market, it is possible to buy or sell things for delivery at some specified date in the future. The reason the futures markets developed formally a couple of hundred years ago, and are so important to the world economy, is that they enable producers and consumers to offset the risk of price changes to those willing to take the risks.

Assume you are a farmer and estimate that you can produce corn this year for $5 a bushel, and at the moment corn is selling for $7 a bushel. At $2 a bushel profit, corn is the most lucrative crop you can produce, so you plan to expand your corn plantings. You rightly fear that other farmers will also plant more corn. But this additional corn could cause the price to drop, especially if Congress sensibly reduces the foolish, corn-based ethanol mandate it passed. If the price falls to $3 a bushel, you will go bankrupt.

Fortunately, futures markets exist, which enable farmers to sell a portion of their crop for future delivery (e.g., September, when the crop is in) at today's high prices. This will protect them from a large drop in prices - known as "going short." The other side of the bet might be made by breakfast cereal companies who fear that if corn prices continue to rise, they will not be able to pass the price increase to their consumers, so they want to protect themselves by locking in the current price of corn - known as "going long." Both the farmer and the cereal companies are "hedging their bets" about the future price of corn. There are many corn market speculators who provide liquidity to the market and fill the void if the numbers of short and long hedgers do not match up.

The same principles hold for oil. If you are a small oil producer and know that if you drill an expensive but possibly low-producing well, oil will have to sell for more than $60 a barrel for it to be profitable. Thus, if you can sell some of your future expected oil production at a price higher than $60 in the oil futures market, it will likely be profitable and, hence, you are willing to take the risk of the costly investment in expanded production.

On the other side, assume you are the manager of your city's municipal bus system. You must provide the city council with an estimate of what your diesel fuel costs will be next year so it can properly allocate the city budget. If there is an unexpected price rise in diesel fuel, you will not have enough for all of your buses and will have to curtail bus service. This will anger the citizens, the council members, and also may cost you your job. Fortunately, you can "go long" on the diesel oil futures market, safeguarding the city in case of a price rise of diesel fuel, protecting your job and the bus-riding citizens.

As with the corn example, oil speculators, some of whom have "gone long" and some of whom have "gone short," provide the necessary liquidity and mismatch between the various hedgers.

The current political charge is, "the speculators are driving up the price of oil." But think about it for a moment. If the price of oil is being driven above the market clearing price where supply equals demand, demand will fall and the speculators will be stuck holding huge, unintended stocks of oil. Holding oil in tanks and ships is costly, and speculators will not incur these costs for long, so the price will drop. Some in Congress want to curtail the activities of the speculators by increasing regulation. This will only drive more of the energy markets to other countries, thereby hurting the U.S., and will do nothing to reduce the price of oil.

The price of oil is higher than it would be in a totally free, private global market, because other countries' state oil companies own 88 percent of the proven reserves and many of them are part of the OPEC cartel. Much of the oil that could be produced in the U.S. and elsewhere by private parties has been made off-limits by governments. Speculators are not the problem; they are part of the solution, by reducing the risk for producers, refiners and other oil market participants. This risk reduction results in more production of oil, other fuel, food and metals where futures markets exist.

Just what is pushing prices skyward? Surprisingly, the G-8 finance ministers failed to mention the US dollar’s role. Every commodity trader knows that all commodities trade off changes in the value of the greenback. When the value of the dollar falls, the nominal dollar prices of internationally traded commodities, like gold, rice, and oil, must increase because more dollars are required to purchase the same quantity of any commodity. Accordingly, a weak dollar should signal higher commodity prices. And it does.

For example, if the greenback had held its January 2001 value against the euro, oil would have traded at about $76 a barrel in May 2008. This is almost $50 below the price that crude oil was trading at in May 2008. Accordingly, the decline of the dollar’s value accounted for a whopping 51% of the $97 a barrel increase in the price of oil from May 2003-2008.

In addition, global economic activity and the demand for crude oil have been strong since 2003. This has been accompanied by weaker growth rates on the supply side of the oil market. In consequence, excess capacity has declined. These smaller margins of safety and the fact that a large share of global oil production occurs in politically unstable regions result in larger risk premiums that contribute to higher oil prices.

To obtain a better grasp of the dynamics of the oil market, consider the market for light sweet crude oil traded on the New York Mercantile Exchange in New York. The accompanying chart shows the prices for futures contracts. These are agreements between buyers and sellers to exchange oil at a later date (July 2008 – December 2010) at a price fixed “today” (either June 5, 6 or 13, 2008). Among other things, it is clear that market participants expect oil prices to remain elevated.

In addition, the chart shows the record jump in crude prices from June 5 to June 6 and also the prices one week after the jump. These three curves contain information that can be used to calculate the term structure of interest rates for oil. These commodity (or “own”) interest rates are presented in the accompanying table. They provide important insights into the workings of oil markets.

Before interpreting the commodity interest rates, it is important to realize that futures markets operate as loan markets for commodities. As such, they operate in a manner that is similar to money markets. When a handler of commodities purchases a commodity and simultaneously sells a futures contract, he is temporarily borrowing a commodity. This procedure is much like borrowing money from a bank with the promise to repay the loan in the future. The sales of a futures contract, in conjunction with the purchase of a commodity in the spot market, allows a handler to borrow a commodity now and repay it later. These simultaneous buy-sell transactions are, therefore, implicit commodity loans.

If the price of a commodity for future delivery exceeds the spot (or cash) price, the market is in contango, and the commodity interest rate is negative. A lender of a commodity has no incentive to lend to the spot market because he would be in effect selling low and buying high. The reverse occurs when the spot price exceeds the futures price and the market is in backwardation. Commodity interest rates are positive. In this case, it pays those who hold commodities to loan them to the spot market.

When the price of oil made its record jump on June 6, many conjectures were made about the causes. The one that turns out to be the most plausible is the threat made by the Deputy Prime Minister of Israel, Shaul Mofaz. After Mr. Mofaz stated that an Israeli attack against Iran was “unavoidable” if Tehran continued to push forward with its nuclear program, the curve for futures contracts prices shifted up and its shape changed. With the change in shape, the commodity interest rate switched from negative to positive for 2008. In other words, it became profitable to lend oil to the spot market. This occurred because the precautionary demand for oil became elevated as oil users became concerned about a possible Israeli attack on Iran and the adequacy of their inventory levels. After Israeli defense officials rebutted Mr. Mofaz, concerns were dispelled and the commodity interest rates became negative for 2008, indicating a more relaxed precautionary demand and more adequate inventory levels.

Mother hoard

Speaking of inventories, let’s examine the world’s largest – the US government’s Strategic Petroleum Reserve. The SPR is a response to the oil embargo imposed by the Organization of Arab Petroleum Exporting Countries after the 1973 Arab-Israeli War. It comprises five underground storage facilities, hollowed out from salt domes, located in Texas and Louisiana. By 2005, the SPR’s capacity reached its current level of 727 million barrels. At present, 702.7 million barrels are stored in the SPR. That’s over twice the size of private crude oil inventories. To put SPR’s size into perspective, its current storage would cover about 71 days of US crude oil imports or 47 days of total US crude oil consumption. The SPR’s drawdown capacity is 4.3 million barrels per day. That rate is slightly greater than the combined daily crude oil exports from Iran and Kuwait. In short, the SPR is huge.

Not being faced with capital carrying charges and never wanting to be caught short, government officials, like proud pack rats, want to just sit on this mother of all commodity hoards. They argue that the SPR represents an insurance policy for national emergencies. But without a specified release rule, just what is the insurance policy written for?

Instead of hoarding the SPR, the government should sell outof- the-money (at strike prices that exceed the current spot price) call options on the SPR. This would allow the purchasers to buy oil at the strike price until the option contracts expired. It would transform what is in effect a dead resource into a live one. It would provide the country with a huge inventory of oil, generate revenue to defray some of the government’s stockpiling costs, smooth out crude oil price fluctuations, and push down spot prices relative to prices for the oil to be delivered in the future. In consequence, commodity interest rates would become very negative as inventories would be abundant.

A stronger dollar and market-based release rules for SPR would provide relief from sky-high crude oil prices.

But, much as politicians would like to blame speculators, it's just not so.

For starters, there's nothing about futures or options that makes it any more attractive to bet that commodity prices will go up than to bet they'll go down. Guess wrong on the direction, and you lose money.

The "blame speculators" theorists have several worries. Investors in oil futures don't take delivery of oil, they note with unexplained suspicion. More, futures and options may involve margin debt and leverage - meaning you might need put only, say, $8 down to make a $100 investment (though you're still liable for the whole $100 if you've bought a lemon). And there's been a marked rise in investing in commodity-index funds, greatly increasing the total amounts in those markets.

The first complaint is irrelevant nonsense: Investors in oil futures don't take delivery of oil because they sell their contracts before the contract expires to oil refiners and distributors - who do take delivery of oil.

Yes, if the price of next month's oil futures goes up, that can encourage producers to slow their sales on the spot market. And a higher price for next month's oil can encourage refiners to buy more now rather than later. Both reactions could push the cash price up.

But they would also cause oil inventories to rise. And rising inventories always bring the price back down. Yet US oil inventories appear modest at present - so there's little evidence that speculation had much to do with recent prices (aside from one-day spikes from scary rumors or news).

The second fear turns on the use of leverage and debt. This is mainly concerned with options (derivatives), because that's where a small down-payment can control a lot of oil.

But there's no more incentive to bet that the price will go up (called a "call option") than to bet it will go down (a "put option").

A call option might guarantee the right to buy oil for $138 three days before the futures contract expires. But if that price turns out to be too high, the option becomes "out of the money" - worthless.

And speculation that oil prices will rise rather than fall has dropped drastically since we crossed $100 mark. The "net long" position on the New York Mercantile Exchange fell from 113,307 contracts on March 11 to 25,246 by June 10 -so nearly as many traders are now shorting oil as are going long.

More: Purely financial speculators needn't play futures at all. They can simply buy (or short) the exchange-traded US Oil Fund, which tracks the price of West Texas crude. And The Wall Street Journal reports that short interest in that fund is up 140 percent since January, outnumbering long bets by two to one.

Speculators, in other words, are increasingly leaning toward betting the price of oil will go down, not up. So they're unlikely villains if prices do keep rising.

The third worry centers on investments in commodity indexes by pension funds and college endowments. But this contradicts the second complaint - because these institutions by law can't use leverage or debt.

Index funds simply buy next month's contracts and sell them early, during the second week of the month, using the proceeds to buy the following month's contract. And such mid-month trading can't affect the price that matters - when futures expire.

The witch hunt got a boost from recent testimony to Senate Homeland Security Committee by Michael Masters of Masters Capital Management, who claims that an influx of cash into commodity-index funds has caused the rise in world commodity prices.

First problem here: The same period saw vastly larger investments in stock-market-index funds - yet the S&P 500 stock index sometimes fell.

By the way, some acolytes are getting this theory wrong. A Washington Post editorial this week cited Masters as blaming hedge funds. In fact, he explicitly blames pension funds and university endowments for investing in those commodity-index funds. (In fact, that strategy is far too cautious for hedge funds.)

In any case, investing in an index of commodity prices can't lift the prices of individual commodities - any more than investing in stock-index funds could automatically raise the value of individual stocks in the index.

Another variation: Some argue that the sheer increase in the volume of future contracts must have lifted the prices of commodities. Sorry, no: Volume tells us nothing about futures-contracts prices - just as the overwhelming volume of stock trades on Oct. 19, 1987 (Black Tuesday) did not mean stocks were going up.

From November 2000 to November 2001, the volume of crude oil futures contracts in New York rose from 2.8 million to 3.2 million - even as the price of crude fell from $34 to $20.

There is no mystery behind the rise in oil prices. They rose too high too fast because of booming demand for oil for petrochemical products, electric power and shipping from many emerging economies (particularly China, India and the Middle East). Meanwhile, the supply of oil slipped in the US, Mexico, Venezuela, Nigeria and Russia.

But now JPMorgan analysts estimate that oil will drop to $85 a barrel from 2009 to 2011. Even Goldman Sachs analyst Arjun Murti, who recently guessed oil might reach $200, later told Barron's that oil will likely drop to $75 or less in the long run.

The urge to blame speculators is as big a waste of time as blaming oil companies. Americans want more oil and gas - not more hot air from politicians.

Six months of hand-wringing later, domestic prices had been allowed to increase further, and by proportionately much greater amounts—well in excess of 100% and enough to cause considerable public disquiet. Fearing the voters' wrath, the president promised no further energy price increases until after the next presidential election, which was not due for another four years.

But this rash promise soon came back to haunt him. Global oil prices continued to increase rapidly, and the subsidies for fuel and electricity consumption quickly returned to earlier levels and then began to surpass them. Chronically unable to bring itself to accept reality, the government produced a draft budget for 2008 based on a projected oil price of $60 per barrel. By the time that budget was enacted last November, the price had risen to $90. After more months of agonizing, the $60 estimate was adjusted to $95 in late March—by which time the actual price was already above $100 and still rising by the day.

With oil at $100, energy subsidies for 2008 would have ballooned to an estimated $26 billion, a far cry from the $8 billion price tag attached to the original $60 per barrel assumption. Surprisingly, most of the debate on domestic energy prices has focused on the impact of growing subsidies on the budget deficit if prices remained unchanged. This would actually have been quite small, since the government derives large revenue increases from the oil and gas sector as the prices of these commodities rise. The likely impact on inflation has also created considerable interest, though it, too, would be modest.

Of far greater importance are the injustice and the sheer waste of valuable resources that result from energy subsidies. In short, Indonesia plunders its energy resources to finance current consumption—with 66% of the subsidy going to the wealthiest 40% of the population—instead of funding investment in human capital and infrastructure. Eliminating these subsidies would enable the government to more than double both the approximately $11 billion budgeted for capital expenditures and the $7 billion budgeted for health care and education.

For a very different story, all we have to do is flashback to 1973, when the OPEC cartel first began to flex its muscles. The resulting huge increases in world oil prices generated an enormous boost to Indonesia's exports and a corresponding surge in government revenue. For all his faults, former President Suharto had the good sense to make sure that a very large proportion of these revenues was reinvested in infrastructure, education and health care. Even the considerable windfall gains that found their way into the pockets of his cronies were largely reinvested in private-sector activity. Much of the explanation for Indonesia's remarkable economic progress during the Suharto era—including poverty reduction—can be found in these policies.

In contrast, the enormous increases in world oil prices over the last few years are not seen by the current president as a golden opportunity to increase spending on badly needed infrastructure, or to bring about improvements in the quality and quantity of education and health services. Such possibilities have been virtually ignored, and what could be a second oil boom is instead being dissipated under misguided energy policies.

The domestic energy price increases that took effect May 24—an average increase of 29%—are but a small step in the right direction. They still leave domestic prices far below world prices, and most of the subsidy reduction will be used to compensate the poor by way of targeted cash transfers and the provision of subsidized rice—consumption, not investment.

A disappointing aspect of all this is that the government still has not been able to bite the bullet and foreshadow further upward adjustments in energy prices, much less allow domestic prices to move automatically in line with world prices in the future. Yet it is the government control of these prices that makes changing them politically fraught—which means that adjustments are unduly delayed, and that they therefore become larger and more difficult to digest.

Somewhat inexplicably, given the long advance warning that domestic fuel prices would rise, the relevant authorities were still not ready to implement the necessary increase in public transport fares. The resulting protests and strikes by minibus drivers, for whom more expensive fuel translated immediately into significantly lower earnings, were as predictable and justified as they were avoidable.

Other protests have been driven mainly by student activists from various universities, whose tertiary education does not seem to have imbued them with the inclination to properly analyze the policy issues involved. Absent this analysis, the conclusion is always the same: Price increases are bad, end of story. Perhaps their response might have been different if the government had been able to couch the fuel price increases in terms of a reallocation of spending away from consumption subsidies and into investments in Indonesia's future.

Five years ago this week, gasoline cost an average of $1.43 a gallon at the pump; this week, it's $3.94. And home electricity averaged 5.43 cents per kilowatt-hour in 2003; it was up to 10.31 cents in December.

The underlying cause, of course, is that oil, coal and natural-gas prices have all gone berserk - with no relief in sight.

What to do?

Individually, of course, most of us will start conserving - people are already driving less, buying more fuel-efficient cars, etc. We'll keep on finding ways to save as prices stay high.

Should the government mandate even more conservation? No, "too much" conservation is as economically harmful as "too little." Just consider the economic harm that would be delivered by, say, capping speed limits at 30 miles per hour, or banning recreational long-distance travel. Both would save gobs of energy - but at the cost of doing more harm than good.

The only thing government should do on this front is ensure that prices are "right" - that is, that they reflect total costs. That's mainly an issue for electricity, where retail power prices typically bear little relation to wholesale prices. State governments need to encourage real-time pricing of electricity - so that consumers will get the signal to, for example, run the clothes dryer at night, when power is cheaper.

(Incidentally, those who argue that gas and diesel prices don't reflect important "external" environmental and national-security costs are simply wrong - at best, those added costs are trivial on a per-gallon basis.)

But there's a fair bit to do on the supply side. Congress could take four positive steps - if it really wants to bring prices down.

Open up key areas for oil and gas exploration and development. Washington has declared the Arctic National Wildlife Refuge and 85 percent the outer continental shelf off-limits. It's absurd for our politicians to fulminate about the need for more oil production from OPEC when they won't lift a finger to increase oil production here at home.

That said, it will take years to get these fields on-line (all the more reason to start now!) - and they'll do more for natural-gas prices than for oil.

By the time those new fields would be producing, global oil production will probably be about 100 million barrels per day. Optimistically, the fields would yield about 3 million more barrels a day - for a long-run cut in the price of crude of about 3 percent.

But US natural-gas reserves are almost certainly far greater - and gas prices are highly sensitive to regional (rather than global) supply and demand issues, so we'd likely see far greater reductions in electricity prices.

Open up the West to oil-shale development. The United States has three times more petroleum locked up in shale rock than Saudi Arabia has in all its proved reserves. But this US oil is costly to extract. Oil prices need to be at at about $95 a barrel to allow a reasonable profit from extracting oil from Rocky Mountain shale.

Well, it's probably profitable now; there's undoubtedly great investor interest in harnessing shale. Only problem: It's mostly on federal land; Washington has so far said, "Hands off!"

Environmentalists object to both these first two ideas - insisting that the wilderness that would be despoiled by energy extraction is worth more than the energy itself. That's nonsense - faith masquerading as fact.

How much something is worth is determined by how much people are willing to pay for it. If these lands were auctioned off, energy companies (the market representatives of energy consumers) would outbid environmentalists for virtually all of them.

Empty out the Strategic Petroleum Reserve. This now holds 700 million barrels of oil; draining it could add add up to 4.3 million barrels of crude a day to the market for about five months. That's nothing to sneeze at - it's about half of what the Saudis now pump and almost twice what Kuwait puts on the market.

At the very least, this would bring gasoline prices down. And if the theories of a speculator-created "oil bubble" are true (I doubt they are), it would pop the bubble and send prices tumbling.

What of the national-security risk? Another myth. As long as we're willing to pay market prices for crude oil, we can have all the oil we want - embargo or no embargo.

A real US physical shortage is impossible unless a) all international oil actors refused to do business with us - which won't happen, or b) a foreign navy stopped oil shipments to US ports - which the US Navy is more than competent to prevent.

Opening this spigot now also means a $70 billion windfall for the US Treasury.

Suspend (or end) federal rules that force refiners to use only low-sulfur oil to make gasoline and diesel. This is easily the best short-term fix for high gas prices.

Refiners were once relatively free to use heavy crude to make transportation fuel. Today, environmental regulations make it difficult and costly. And there's actually a (relative) glut of heavy crude right now.

Light-crude oil markets are incredibly tight, with no real excess production capacity. Heavy-crude markets are robust, with plenty of crude going unsold for lack of buyers.

Suspending low-sulfur rules would bring those heavy crudes into the transportation fuels. Oil economist Phil Verleger says it could well send gasoline and diesel prices plummeting.

The fact is, food riots resulting partly from the United States' alternative energy policies have arrived at our front door. Crowds of hungry demonstrators swarmed the presidential palace in Haiti last week to protest skyrocketing food prices.

In recent years, we've heard that climate change could be catastrophic for nature and humanity. But it's becoming increasingly evident that over the next few decades, climate-change policies could prove even more catastrophic.

Food riots have erupted in Mexico, Morocco, Egypt, Cote d'Ivoire, Guinea, Mauritania, Cameroon, Senegal, Uzbekistan and Yemen. Vietnam, Cambodia, India and Egypt have all placed restrictions on their rice exports to drive down domestic prices. Pakistan has reinstated food rationing, which is also under discussion in Bangladesh and rumored in Sri Lanka.

Supposedly climate-friendly policies in the United States and the European Union — subsidizing the production and consumption of such renewable biofuels as ethanol and biodiesel — have diverted such crops as corn, soybeans and palm oil from food to fuel. This, in turn, has increased prices for food worldwide at a time when the highly populous and newly prosperous East and South Asian countries are demanding more of it.

Together, China and India constitute 40 percent of the world's population. Not long ago, these countries were on the brink of starvation, but now they're seeing food demand rise ever higher because of years of near double-digit economic growth rates. Energy — critical for making fertilizers, transporting food and running equipment — is at record prices.

According to World Bank data, by March of this year, grain prices had tripled, fertilizer prices had quintupled and energy prices were up 21/2-fold since 2000. Since January of this year alone, food prices have increased a staggering 65 percent.

These food-price spikes threaten to undo one of the world's signal post-World War II achievements. In the '50s and '60s, many feared that famine was inevitable. Instead, we witnessed a vast reduction in chronic hunger, from 37 percent of the developing world's population in 1970 to 17 percent in 2001 — despite an 83 percent increase in population.

Increased agricultural productivity, trade in food commodities and aid from the developed world resulted in a 75 percent drop in global food prices after 1950, making food available to the bottom-rung billions worldwide. The current bump-up in food prices threatens to reverse these gains.

The conversion of natural habitat land for produce-cultivation purposes had been the single-largest threat to biodiversity worldwide, but over the last half century, the global agricultural footprint has nearly stabilized. Now, this achievement is also in jeopardy.

What the US ethanol subsidies do for corn, the European Union's biodiesel subsidies do for palm oil. EU policies stoke an artificial demand for biodiesel, leading to the clearance of high-biodiversity forests in Malaysia and Indonesia. In both the European Union and the United States, lands previously set aside for nature conservation are once again coming under the plow to meet subsidized biofuel demand.

Agricultural expansion, in turn, increases pressures on certain animal species and leads to higher releases of carbon, from biomass and soil above and below ground. Fertilizers used to increase agricultural yields also increase nitrogen discharged into waters and emissions of nitrous oxide — a greenhouse gas that heats the atmosphere 300 times more effectively than carbon dioxide.

Thus, even if biofuels produce an energy surplus, they would not necessarily be environmentally sound. Worse, they harm the US economy. Higher energy and food prices reduce consumers' disposable income more or less equally, meaning they disproportionately affect poorer people. Higher food prices, alternative energy subsidies and greenhouse-gas-emissions controls only make it harder for these people to earn a living or afford better education and health care.

Climate-change remedies can lead to greater poverty, starvation and disease, as well as widespread ecological destruction — some of the very misfortunes that they're supposed to prevent. In our haste to address global warming, we have yet to think seriously about our policies' unintended effects.

The results have been disastrous, and they're only getting more so.

Wait a minute. Hurricanes have been a fact of life for the forests of southeastern North America ever since there were forests, and that's a pretty long time.

The natural vegetation of the coastal southeast consists largely of a mixture of Pine and Oak species. That's not what it is today, because today's vegetation isn't natural. Rather, it's virtually all a commercial mix of softwoods designed to grow fast and tall, so the trees can quickly be sawed into houses. Today's forest probably maintains a higher vertical profile than the one that was here before, and it's also largely protected from fire, but not from hurricanes.

Back before us, believe it or not, weather was pretty much the same as it is now. Consider the very severe drought currently plaguing the Deep South. Remember those forest fires in Georgia late last summer? The only reason they didn't burn down most of the state's forests was that they were unnaturally extinguished.

It's fair to say that the integrated intensity of the southeastern drought may be a one-in-fifty year occurrence. That would mean, in a "natural" world (i.e., one without human sprawl) a southeastern forest would go about fifty years before combusting.

Or, perhaps, taken down by a hurricane. Pines and oaks have been around about 100 million years. Hurricanes have been around longer.

Here's the cool part: the present era. Ninety-five percent of the last 100 million years were warmer than now. It's only about 5 million years or so ago that we began to slip into the current ice-age climate (from which carbon dioxide may mercifully extricate us, some say).

Now, just for fun, let's assume that Katrina was a product of global warming. Forget that no scientist will stand up and point the causative finger. But, if it was, Katrina was therefore typical of many hurricanes of the last 100 million years. In other words, the natural southern forest evolved in a world studded with Katrinas.

Part of the modern climate mythology is the assumption that every significant climate burp, such as the big El Nino of 1998, or the big hurricane season of 2005 is portentous of ecological disaster. Hardly. In fact, if today's species were not adapted to these extremes, they simply wouldn't be here.

It's almost too bad that we don't have the "natural" forest of southeastern North America anymore. I'll bet, if we did, that some ecological researcher would have discovered indeed that such a forest in fact requires hurricanes, just as the flowering plants of the desert southwest require El Nino rains for germination and subsequent reproduction.

There once was a concept of "potential natural vegetation" of the United States, which was thought to be what would eventually appear in the absence of human management. The modern view of forest dynamics is somewhat different, but, nonetheless, the "natural" distribution of the oak-pine forest pretty much corresponds to the inland reach of the strongest hurricanes.

OK, that was my original Ph.D. topic proposal, back in a 1971 paper at the University of Chicago. It was laughed at, because, at the time, ecologists didn't think weather or climate were very important modulators of ecosystem behavior. Four years later, the surface temperature of the planet began to rise. About a third of a century later, a hurricane was blamed for the largest ecological disaster in our history.

Now it's the other way around. Weather and climate are now assumed to be driving the world into ecological chaos. It seems reasonable that, say, 30 years from now, something else will be to blame.

Finally, whenever a hurricane (or a fire) takes down a forest, it's not replaced by anything but another forest. That vegetation will absorb some of the carbon dioxide that Katrina's trees left behind. It will eventually look a lot like the one that got blown down, only to await the sawmill, or the next big hurricane.

There is enough liquid oil in the ground to last generations; and when oil sands and oil shale are included, there is enough oil to last centuries. If there were a truly free market in oil, with both the reserves and production owned and controlled by many competitive companies, the price of oil would be a fraction of today's price.

The high price of oil is a direct consequence of artificial supply constraints imposed by the Organization of Petroleum Exporting Countries and other countries, including the United States, and the incompetence and mismanagement found in most state-owned oil companies. OPEC is an international government cartel made up of Iraq, Iran, Kuwait, Libya, Angola, Algeria, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela. These nations control about 77 percent of the world's known liquid crude oil reserves.

Most of these countries and other major oil producers that rely on mainly state-owned companies, such as Russia, have underinvested in exploration and development of new production facilities and mismanaged the ones they have. (If politicians understood the facts and were truthful, they would rant against "greedy" socialists rather than private oil companies.)

Venezuela, despite having perhaps the sixth-largest oil reserves in the world, has falling production because of the mismanagement by the Chavez government. Mexico also is suffering from falling oil production because the government refuses to allow private oil exploration and production companies, and the state-owned oil company, Pemex, is corrupt and incompetent. By contrast, the U.S. only has about 2 percent of the world's oil reserves, but produces little more than 8 percent of global production, largely because they are privately owned and managed.

A decade or two from now, the socialist states will have severe regrets for their current misbehavior, and this is why. When prices rise, people seek alternative sources and substitutes for the high-priced commodity. When oil prices are above $30 or $40 a barrel, suddenly the Canadian oil sands and Colorado oil-bearing shale become economic, and those reserves are larger than known liquid oil reserves.

The short-run problem is that development of oil sands and oil shale requires enormous up-front investment and many years. Canadian oil sand production is now ramping up rapidly, but it will be a few years before it can replace most of North America's needs for oil from outside the continent.

Recently, there has been additional good news. Shell Oil has announced its new in-situ (i.e., in-ground) extraction technology in Colorado could be competitive at prices of more than $30 per barrel. However, it will take quite a few years to get into major production.

Despite the current infatuation with biofuels, they are unlikely to ever produce more than a small share of the market because they are not price competitive with liquid, sand and shale oil when all attendant costs are taken into account, such as higher food prices. Petroleum accounts for about 40 percent of U.S. energy supply and about two-thirds of it is imported. Most petroleum is used for transportation, which accounts for about 28 percent of U.S. energy use.

Now, for the really good news. The new car you purchase a decade from now is almost certainly to be totally electrically powered. Huge strides are being made in battery technology, and even existing batteries have just about reached the point where they are sensible for automobiles. Mitsubishi has just come out with an all-electric car, the sport MIEV. And Nissan and Renault have announced they will be in full-scale production of electric cars by 2012.

As people move to electric cars, the need for gasoline and imported oil will quickly disappear. Nuclear and clean coal plants must expand to produce the additional electricity, but they produce energy at a fraction of the cost of petroleum. The new battery technology will also help solar and wind power become more economically feasible because they will be able to store it. Even so, solar and wind will only be a small part of our energy future because of their inherent production limits.

In sum, a decade from now, the world will no longer be held hostage by the socialist OPEC cartel. Liquid fuels (oil) are mainly needed for transportation; but when electricity takes over much of that market, America, Europe, China and Japan will find they can produce all of the electricity they need from nuclear, coal, hydro, biomass, geothermal, solar and wind resources.

North America will also be independent from foreign oil because of the oil sands and oil shale developments, which are likely to be protected from drastic reduction in world oil prices. OPEC and its fellow travelers will be left with a far less valuable commodity, because their present, shortsighted, high oil price strategy is causing their customers to develop economically and environmentally sound alternatives more quickly than if there had been a truly global free market in oil.

But is ethanol a truly renewable energy source, and is it more secure and dependable than oil? The answer to both of those questions, surprisingly, is no.

First of all, ethanol is not currently produced in a "renewable" manner — the production process is almost completely dependent on fossil fuels such as coal, natural gas and diesel. Furthermore, a recent study published in the Proceedings of the National Academy of Sciences shows that even the nonrenewable production of ethanol could displace at most 14 percent of U.S. gasoline consumption — if all of the corn grown by American farmers were devoted to ethanol production.

If ethanol were produced in a manner that did not require fossil fuels, only a trivial amount of fuel would make it to the pumps. To see why this is so, consider a 2002 U.S. Department of Agriculture study — one trumpeted by ethanol proponents — that estimated how much energy is used at each stage of the ethanol production process. If we assume that the USDA's calculations are correct, but instead of using fossil fuels to provide the energy at each stage we suppose that a portion of the produced ethanol itself is used, we make the process self-contained or sustainable. In this case, processing all the corn in the country would displace about 3.5 percent of our gasoline consumption. That is about as much as the Natural Resources Defense Council estimates we would save if we simply inflated our tires properly. Also, bear in mind that the United States is responsible for about 70 percent of global corn exports, so even small diversions of corn supplies to ethanol could have dramatic implications for food prices and the health of the world's poor.

Another ethanol shortcoming is that it is not very secure. While it is true that U.S. corn yields have increased substantially over the past few decades, researchers have observed that the year-to-year percentage gain has steadily declined. The rate peaked around 4 percent in the early 1960s and was less than 1.5 percent in 2001. That growth rate is not expected to keep up with food demand.

Moreover, variability in U.S. corn yields appears to be increasing, a point that is underscored by this summer's drought. Researchers predict that, even under the best-case global warming scenario, corn yields are likely to decline by 22 percent in the short-run.

For the sake of argument, let us be optimistic and assume yield variability will remain within historical parameters. We can then use data from the National Agricultural Statistics Service to estimate the frequency and size of ethanol disruptions that we should expect in the future. We then can compare this variability to the variability in oil imports.

Specifically, let us consider the time period 1960-2005, a period that included, among other oil shocks, the Six-Day War, the Arab oil embargo, the Iranian revolution, and the outbreak of the Iran-Iraq War. If variations in the supplies of both corn and oil during this period are a reasonable guess about future variability, then in any given year we should not be surprised if corn yields decline by 11.9 percent. In contrast, a typical decline in Middle Eastern oil supplies would be only 6.8 percent. Moreover, in one out of every 20 years, we would expect corn yields to decline by 31.8 percent, while the corresponding disruption in the oil supply would be only 14.9 percent. Thus, based on history, displacing gasoline with ethanol would exchange geopolitical risk with yield risk. History suggests that yield risk is about twice as high.

Lastly, relying on ethanol exposes the economy to an entirely new risk: the link between ethanol supply disruptions and ethanol demand shocks created by their common dependency on weather conditions. For example, a summertime heat wave would increase the demand for ethanol as drivers travel longer distances on vacation to escape the heat, spend more time on congested roads, and use their cars' air conditioning more intensely. At the same time, because corn yields are especially sensitive to rainfall shortages during July and high-temperatures during August, the heat wave also would likely reduce corn yields, thereby increasing the price of corn and the cost of producing ethanol. In this way, weather would adversely affect both the supply of and demand for ethanol. Gasoline does not suffer this risky linkage; though drivers would still travel further on vacation and use their air conditioning during a heat wave, there is no apparent connection between summertime heat and the supply of gasoline.

The actual strength of this weather-induced relationship is unknown, but it nevertheless provides another reason to suspect that there may be better energy alternatives to ethanol. Perhaps, instead of using coal and natural gas to create ethanol, it may be more efficient to use natural gas or liquefied coal to power cars directly. Or, maybe, if we want a renewable solution, we could use solar panels to generate electricity for electric cars (solar panels capture far more solar energy than corn). These may or may not be good alternatives, but the point is that there are alternatives to ethanol that consumers should explore. Because the technologies and energy markets are incredibly complex, we shouldn't have great confidence that politicians, using billions of dollars in subsidies, will pick the best one. Legislators could better serve the public by mandating the use of alternative fuels or a cap on particular emissions and then allowing the market to reveal the best options for accomplishing those goals.