The Political Economics of Alternative Energy

By Daniel O'Connor of Integral Ventures, LLC

Deinonychus Antirrhopus questions the validity of popular arguments favoring alternative energy sources:

One of the things we frequently hear is that we need alternative sources of energy so that we can reduce our dependency on foreign oil. The implication is that since the foreigners have the majority of the world’s oil, they can set the price and thus, the higher prices are bad for our economy. While the conclusion is right, the idea that switching to alternatives will solve this problem is dubious at best. A simple example might help.

There is a country that imports the bulk of its oil, and the cost is $10/barrel. Further, lets make this an extreme case and assume there is only one foreign exporter of oil so that the price is the monopoly price. Given that this is the monopoly price it is a price higher than the competitive price. Now, there is also an alternative source of energy, but exploiting it with the current technology results in an equivalent price of $15/barrel. Suppose the usage of oil in our little country is 100 barrels, so the total cost is $1,000. The cost for using the same amount of energy with the alternative is $1,500.

So what are our policy options at this point? We could mandate that only the alternative is used, but this would result in people reducing consumption and paying more per barrel. The total energy costs would be between $1,000 and $1,500. We could subsidize the alternative energy so that the consumer only pays $10/barrel. But this means that we’d also have to increase taxes somewhere between $0 and $500. Total costs (excluding for the moment the deadweight loss associated with taxes) would again be between $1,000 and $1,500. We could subsidize research into technology associated with the alternative fuel so that it becomes cheaper. Again, since we’d still need a tax for this and depending on how much we spent on research we’d have total costs in excess of the $1,000 we are currently spending on oil alone.

Now one could look at the above and say, “Gee, no policy looks good other than doing nothing.” Which ironically is a policy option, but one that politicians almost never ever talk about since what politician wants to be seen as literally doing nothing. The last one does have a possibility of having some benefit to it. If the technological research develops enough so that switching to the alternative makes sense, then it is likely that as technology continues to improve we’d end up paying less and no longer paying the monopoly price. Thus, the last solution does have some possible positive benefits associated with it. However, it could also be argued that such research is better left to the private sector.

But short of that, most of the current arguments for “reducing our dependency on foreign oil” for economic reasons are just baloney. When politicians open their mouths and start blabbering on about the economic costs of being dependent on OPEC and foreign oil, they are just spouting jingoistic nonsense. And this is what we see with most of the President's energy bill, that and pork, nice yummy corporate pork. It has tax incentives for hybrid cars, drilling in ANWR, subsidies for ethanol, and subsidies for biodiesel are all examples of spreadign the pork around.

Granted, the rationalizations that politicians and lobbyists use to justify state interventions to limit US dependence on imported oil are often questionable to anyone with a basic knowledge of economics.  Nevertheless, those with a knowledge of economics should not ignore the enormous subsidy for the oil industry provided by the US Department of Defense.

Certainly since the Carter Doctrine was first articulated, framing any threat to the supply of oil from the Persian Gulf as the moral equivalent of war, the US government has coordinated energy policy in concert with defense policy.  I did research on this back in the late 1980s, reading through thousands of pages of the Congressional Record.  Even then, one could see the case being made for some future Persian Gulf war.

With oil being thus subsidized for decades, the cost of securing and protecting production and supply being externalized and run through the breathtakingly large and opaque Pentagon budget, reducing the market-clearing price of oil, the quantity consumed has been greater than it otherwise would have been.  This has contributed to even greater dependence on oil, in general, and Persian Gulf oil, in particular, than would have existed in the absence of the subsidy.  It is yet another one of those self-reinforcing dynamics at the intersection of market economics and political economics.  And with the markets for alternative energy being held to a standard of economic performance that even oil could not meet without an extraordinary government subsidy, the research, development, and production of alternatives have been understandably delayed.

Therefore, one cannot legitimately dismiss subsidies for alternative energy as pork barrel politics unless one is willing to simultaneously acknowledge oil as arguably the most subsidized energy industry in history.

© 2005 by Daniel J. O'Connor.  All Rights Reserved.

Comments

[Michael J.]

This analysis assumes that the supply of oil is constant. While the specific date is debatable, it is NOT debatable that oil is a finite resource that will become very costly to extract as it becomes scarce. We will not suddenly one day "run out of oil." Instead, we can expect continuously increasing prices, especially as the markets figure out the ripple impacts of energy price increases on "unrelated" parts of our economy.

Even if new energy technologies could approach the energy density characteristcs of oil, which is unlikely, the real problem is that there is a long time delay to producing new technologies. The ten or twenty years it takes to convert from gasoline commuting to public transit will be very painful, not to mention the de-globalization of food.

If you're not up to speed on the science, I recommend this PowerPoint deck as an introduction. http://cogsci.ucsd.edu/%7Esereno/oil05.ppt

There is also an excellent 91-page PDF called "Peaking Of World Oil Production: Impacts, Mitigation, & Risk Management" by Robert L. Hirsch, of SAIC. Here is a summary http://www.energybulletin.net/4638.html which contains a link to the full report.

[Daniel O'Connor]

Michael,

I get the sense that you're arguing with the portion of my post that I excerpted from the other weblog, though it's not completely clear. You don't seem to be contradicting my argument on the subsidization of the oil industry and the detrimental impact this has had on the development of alternative energy industries. Regardless, I thank you for the references to further reading on Peak Oil.

Daniel

[ebuddha]

If you wouldn't mind, could you please point to how the US government subsidizes oil? Are you speaking of outright subsidies, or 2nd tier effects?

[jeem]

Here's something from my clippings file:

"Americans prefer lower prices at the pump even if they have to pay hundreds of billions of dollars in taxes to support a U.S. military presence in the Middle East. Amy Myers Jaffe has calculated that the cost to taxpayers of oil-related military activities is equivalent to about ten cents per gallon of gasoline. “We are being taxed on energy in this country,” she said. “It’s just hidden.”"

[From The New Yorker, 11/23/04, http://www.newyorker.com/fact/content/?041011fa_fact ]

[Daniel O'Connor]

Excellent article "jeem"... thanks.

My research into this was a long time ago, before the web, so I do not have current sources to cite. But the scale of the subsidy for oil via the defense budget is probably enormous... I would say in the trillions of dollars over these past 35 years... enough to ramp up one hell of an alternative energy sector.

If only the Pentagon was required by law to pass an audit every year, then we might have a few line items to add up and get our answer. But, of course, audits are only necessary for private companies and households.