The Electric Commentary

Monday, August 22, 2005

Black Gold. Texas Tea.

Disaster! Impending doom! What will happen to us if these high oil prices keep going higher!?

Peter Maass at the NYT thinks we're headed for a global recession. Looks like hard times ahead. Or, maybe not:

What most of these doomsday scenarios have gotten wrong is the fundamental idea of economics: people respond to incentives. If the price of a good goes up, people demand less of it, the companies that make it figure out how to make more of it, and everyone tries to figure out how to produce substitutes for it. Add to that the march of technological innovation (like the green revolution, birth control, etc.). The end result: markets figure out how to deal with problems of supply and demand.

Which is exactly the situation with oil right now. I don't know much about world oil reserves. I'm not even necessarily arguing with their facts about how much the output from existing oil fields is going to decline, or that world demand for oil is increasing. But these changes in supply and demand are slow and gradual -- a few percent each year. Markets have a way with dealing with situations like this: prices rise a little bit. That is not a catastrophe, it is a message that some things that used to be worth doing at low oil prices are no longer worth doing. Some people will switch from SUVs to hybrids, for instance. Maybe we'll be willing to build some nuclear power plants, or it will become worth it to put solar panels on more houses.

That's Steve Levitt, taking Maass to school. But it doesn't end there.

Here's Don Boudreaux. Here's Jay Hancock. Here is the Coyote Blog:

One of the problems with oil is that governments have a real problem with allowing supply and demand to operate. I have wondered for a while why Chinese demand has kept growing so fast in the face of rising prices. The reason is that the Chinese government still is selling gasoline way below market rates, shielding consumers from incentives to reduce consumption. On the supply side, I also wondered when I was in Paris why gasoline prices as high as $6 per gallon were not creating incentives for new sources of supply. It turns out that nearly $4 of the $6 are government taxes, so none of this higher price goes to producers or creates any supply-side incentives. Instead, it goes to paying unemployment benefits, or whatever they do with taxes in France.

Even in the US, which is typically more comfortable with the operation of the laws of supply and demand than other nations, the government has been loathe to actually allow these laws to operate on oil. During the 70's, the government maintained price controls that limited demand side incentives to conserve, thus creating gas lines like the ones we are seeing in China today for the same reason. When these controls were finally removed, a "windfall profits tax" was put in place to make sure that producers would get none of the benefit of the price increases, and therefore would have no financial incentive to seek out new oil supplies or substitutes. Within a few years of the repeal of these dumb laws, oil prices fell back to historical levels and stayed there for 20 years.


  • Considering most Americans have discretionary income and discretionary petroleum use, it is likely most will just tighten their budgets, or those who can do so less will conserve more. The real impact is on tangible goods transportation. Trucking will still be the most efficient means for transport for a variety of reasons and Honda Civics are not great at hauling semi-trailers. This increases the cost of goods across the board. This is where the effect will be. I don't know that it will be a huge jump in prices, but it would have a greater proportional impact on lower priced goods such as food.

    By Anonymous Scott H, at 1:57 PM  

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