Bell-bottoms are back, disco lives, and one of the hottest shows on television is a rip-off of Happy Days. And while we no longer have a southern governor in the White House, we do have a Texas governor who, like his Seventies counterpart, has put a lot of political chips on the table to pass a hotly disputed energy bill. There are some differences, of course, but the story line is the same: Unless the feds do something to change our consumption habits, pattern of investment, fuel mix, and appetite for foreign oil, the American economy is headed for dark days indeed.
Washington has always been convinced that energy is somehow different from other commodities, different enough that it can't be left to the market. Nothing, however, could be further from the truth.
At the forefront of this debate, once again, is conservation. Yet there's no more need to conserve energy than there is to conserve Post-it notes. Despite the occasional spike, energy prices have been declining for a century, showing that energy is becoming more abundant -- not more scarce -- with time. It's often thought of as a fixed and finite resource, but energy is in fact a manufactured product. And as our technology advances, our ability to efficiently manufacture energy advances along with it.
Moreover, market signals provide all the incentive necessary to encourage both conservation and the exploration and development of new energy sources. Economists who study energy markets have discovered that in the long run, demand for energy will reflect its availability -- that is, if energy resources become 20 percent more expensive, demand will decline by 20 percent. Why additional conservation efforts are necessary beyond this is a mystery.
Of course, the flip side of the coin is that when energy prices drop 20 percent, demand will in the long run increase by 20 percent. This drives green types crazy, but obsessing about conservation when prices fall, as they have over time, is no more rational than the crazed general's obsessing in Dr. Strangelove about the conservation of "precious bodily fluids."
What about the environmental costs of energy consumption, costs that are not reflected in prices? Government, we're told, must involve itself in energy markets because that's the most efficient way to reduce pollution.
But growing fossil-fuel consumption is not necessarily incompatible with improved environmental quality. Since 1970, for instance, energy consumption has risen by 41 percent, most of it from fossil fuels. But during that same period, sulfur-dioxide emissions (which can cause acid rain) have dropped by 39 percent; emissions of volatile organic compounds (a major contributor to urban smog) have dropped by 42 percent; carbon-monoxide emissions (the main cause of wintertime smog) have dropped by 28 percent; and large particulate-matter emissions (the main airborne cause of lung irritation) have dropped by 75 percent.
There are far more efficient ways to reduce pollution than by restricting fossil-fuel consumption. Widgets put on the end of smokestacks and tailpipes are cheaper anti-pollution investments than are "green" energy sources. The same holds true for greenhouse-gas emissions. Back in 1998, when President Clinton's Council of Economic Advisers issued a report to demonstrate that compliance with the Kyoto Protocol could be achieved without great expense, it was the substitution of natural gas for coal-fired electricity, and a robust international trading regime for greenhouse-gas emissions -- not "green" energy or crash conservation programs -- that turned out to be the elixirs that would keep compliance costs down.
Also, the claim that environmental costs aren't reflected in energy prices is not really true. The costs of complying with anti-pollution laws are passed on to consumers. Are these regulatory costs greater than, equal to, or less than the environmental damages incurred by energy consumption? Harvard's W. Kip Viscusi has examined exactly that question, taking EPA data as an analytic point of departure. Viscusi and his colleagues found that natural gas was probably overtaxed from an environmental perspective, that oil was taxed correctly, and that coal was probably somewhat undertaxed. So environmental costs are already more or less reflected in energy prices.
Leaving the energy supply to the marketplace will ensure that the cheapest sources of energy are exploited first. But here's the rub -- the cheapest source of energy lies in the Middle East, and the geopolitical cost of relying on foreign oil is unpriced in the marketplace. Government, it's alleged, must therefore intervene in energy markets to reduce our reliance on foreign oil.
To paraphrase Jeremy Bentham, this is not simply nonsense -- it's nonsense on stilts. Even if every drop of oil we consumed were to come from Texas, a cutback in OPEC production would raise domestic oil prices just as high as it would if all of our oil were to come from Saudi Arabia. This is because there are no regional markets for oil -- only global markets -- and regional prices invariably rise to the world price. In 1979, for instance, Great Britain was "energy independent": All of its crude oil came from the North Sea. Yet the price spike of 1979 hit Britain as hard as it hit Japan -- a country dependent on imports for its oil. No country can wall itself off from the world market.
The embargo fear is likewise unwarranted. Once oil is in a tanker or refinery, there's no controlling its destination. During the 1973 embargo, some of the oil OPEC exported to Europe was simply resold to the United States; the rest served to compensate for the non-OPEC oil that was diverted to the U.S. market. Then-Saudi oil minister Sheik Ahmed Zaki Yamani later conceded that the embargo "did not imply that we could reduce imports to the United States . . . the world is really just one market. So the embargo was more symbolic than anything else."
Energy prices seem mysteriously volatile, suggesting to many that conspiracies are at work. The widespread fear of unbridled energy markets is reflected in the incredibly tangled regulatory webs spun by the Federal Energy Regulatory Commission, the Federal Trade Commission, the Justice Department, and the various state public utility commissions.
But conspiracies aren't necessary to explain prices. In the short run, energy supply and demand are relatively inelastic. Accordingly, small changes in either can send prices spiraling temporarily upward or downward. And since there are few available substitutes for gasoline or electricity, consumers feel helpless against "the gougers" in a way they wouldn't if, say, tomato prices were to go crazy.
Producers are also victimized by the market's volatility. A recession in East Asia, for instance, can send oil prices so low that no rig in the Lower 48 can turn a profit (which is pretty much what happened a few years ago). Thus both consumers and producers will badger government to protect them when prices undergo their occasional -- but dramatic -- rides.
Yet intervention not only distorts important signals in the marketplace, it robs consumers of energy savings in good times and producers of the revenue they need to offset their losses in bad times. In fact, it was exactly this kind of price control and windfall-profit taxing that caused the energy crisis of the 1970s.
Parts of the energy marketplace are more competitive than others. But the idea that government regulation can control natural monopolies, even where they are found to exist, is more a matter of faith than fact. University of Chicago economist George Stigler in the 1950s, economist Thomas Gale Moore in the 1970s, and several industry economists in the 1980s all found that public utility commissions are demonstrably incapable of keeping monopolists from charging monopoly prices. In a famous and still-unrefuted essay, Chicago law professor and federal judge Richard Posner showed some years ago that government regulation of monopolies -- even natural monopolies -- has actually not improved the efficiency of markets.
To some extent, government's role in energy markets can't be helped. The feds own about a third of America's landmass, and much of that land holds valuable oil, gas, and coal reserves. Federal environmental regulation also greatly affects energy industries. In the former case, economically valuable federal land should be sold off; this is the only objective way to determine whether some lands are more valuable as energy reserves than as sanctuaries for wildlife. In the latter case, government should decentralize regulation to the greatest extent possible and rely on market mechanisms to ensure that the most efficient means of pollution control are employed. Throw in a zero-subsidy policy and eliminate price restraints, and that's the extent of what an energy strategy should look like.
Unfortunately, the Bush energy bill completely misses the mark. While one could certainly make a case for opening up a small part of the Arctic National Wildlife Refuge for oil development, it would probably expand global oil supplies only a bit more than 1 percent a year -- hardly enough to keep the OPEC cartel managers awake at night. The rest of the plan is two parts flotsam to one part compromise, compromises supposedly necessary to buy off environmentalist support for drilling. It's not for nothing that Vice President Dick Cheney boasts that eleven of the top twelve energy priorities of the Sierra Club can be found in the administration's energy proposal, most of which survived in one form or another in the House energy bill passed late last year.Energy markets are important, but that's no reason for government to mess with them. It's really the most compelling reason for government to leave them alone.