Fossil Economics 101

By Mark P. Mills

Even with bombs falling in Iraq this month, oil prices remain stubbornly low, staying as they have for months in the low teens and even dipping into single digits in the spot market.

Oil today is cheaper than it was before the Arab OPEC embargo of 1973 (in real inflation-adjusted dollars)— which comes as a real shock to environmentalists who forecast, nay wished for, the $100 barrel two decades ago.

They may well be wishing still. After all, low oil prices are bad for Kyoto-based goals because they inspire (horrors!) economic growth and thus greater energy use.

Low oil prices might also require journalists and policymakers to take a closer look at the benefits of cheap energy, which has the unintended consequence of protecting America’s greatest energy asset—its carbon-filled coal fields.

The oil price collapse has been big news in the energy business for months and has seeped out into the popular press because of its profound implications for the economy. (One early December Wall Street Journal headline trumpeted "As Energy Prices Continue to Plunge, U.S. Sees a Benefit in Lower Inflation.") But the media have yet to gush.

There are two remarkable things about all the press coverage in recent months, one perhaps obvious, the other less so.

Blatant disregard

First, it is a rare article (come to think of it, I haven’t actually seen one) that, while breathlessly citing the economic value of low-cost oil and energy, even remarks in passing on the obvious linkage to the Clinton–Gore Administration’s climate warming policies, whose stated goal is to raise oil prices.

It doesn’t take an econometrician (a fancier fellow than an economist) to realize that if $12 per barrel is wonderful ("falling oil costs are aiding growth...the biggest boon is lower inflation," as the Wall Street Journal correctly notes), then a high-priced $30-plus per barrel would be terrible economically.

But when writing about the energy implications of global warming policies, most journalists can only manage to skeptically acknowledge "industry" studies that point to the economic punishment from raising energy prices in a Kyoto-inspired world.

Conversely though, journalists do not seem compelled to point to experts or skeptically refer to "industry studies" when making their own observations that cheap oil is great for the economy and consumers.

Cheap oil is self-evidently good for the economy. Yet the media hem and haw: Not that we don’t love the earth, but maybe Kyoto-style policies that will make oil expensive could be, perhaps, well, um, according to the "industry," costly. Such is the nature of the debate.

Subtle disregard

The second issue is a little more subtle, but it really shouldn’t be. U.S. businesses, consumers, and industry collectively buy slightly more than $200 billion per year of petroleum products (roughly 50 percent of it gasoline). If lowering the cost of oil is very good, and conversely raising the cost is very bad, then doesn’t it logically follow that the same economic calculus would apply to another energy commodity on which the U.S. spends $230 billion per year?

And further, if the demand for the former energy commodity (oil) has remained essentially constant for two decades, but the demand for the latter commodity has risen 70 percent in the same time, then surely the price for the second mystery energy commodity should be considered even more critical for controlling inflation and spurring economic growth.

In case you hadn’t realized, that mystery commodity is electricity.

Yet I cannot recall a single instance of a news article comparing the relative economic importance of oil and electricity.

Ignorance is no excuse

More important in these Kyoto-inspired times is that neither have any journalists made their own independent leap of economic faith (as they have in the oil arena) regarding the importance to the U.S. economy of cheap electricity, and derivatively, of coal.

This perhaps (and here I am speculating) arises from the possibility that journalists have about the same level of knowledge as the general public when it comes to electricity.

Here I refer to an annual national survey that has shown each year that:

• Fewer than one-third of the U.S. population knows that most electricity comes from coal-fired power plants.

• More than half of those surveyed volunteer hydroelectric power as the largest source of electricity. (Hydro provides the United States market with less than 10 percent, whereas coal supplies us with 55 percent.)

Indeed, most non-energy folks, and even many ostensible energy pundits, are unaware that our own natural gas–biased Department of Energy forecasts that coal will not only continue to supply 50 percent of all electricity two decades from now, but will make up more than one-half of all the growth in electric supply for the next 20 years. (It is worth noting that even this apparently bullish coal outlook rests on the assumption that natural gas electric supply will grow 550 percent over that 20 years.)

Dial I for impossible

All of these cold coal facts must be held against the backdrop of Kyoto-inspired policies, and many other environmental policies specifically directed at the goal to "dial coal out of the energy equation."

Imagine stating explicitly that we need to "dial oil out of the energy equation." Or more to the point, imagine any journalist reporting this postulate without soliciting and reporting any economic criticism to put the notion into context.

The U.S. economy has grown by more than $3 trillion in two decades, roughly paralleling the growth rate in (cheap, predominantly coal-fired) electricity use.

During that 20 years the absolute use of oil and, by the way, natural gas, has not changed significantly. Meanwhile, the use of electricity has risen close to 70 percent.

So overall, total energy usage is up, but total energy expenditures have remained essentially flat at about $520 billion per year.

What does this mean? Much more economic bang for the buck.

Figure 1. Growth in total economy compared with total energy expenditures. Source: DOE/EIA.

Two decades ago, $1 spent on energy supported $9.50 of the gross domestic product (GDP); today that same $1 can support $14 of the GDP—an economic gain of 56 percent. The net effect: more dollars for new jobs, new technologies, health care, leisure and yes, even environmental goals (real ones). We can have our cake and eat it too as long as energy stays cheap and, most important, gets cheaper yet.

We are talking about both oil and coal-fired electricity, the two energy forms that anchor the entire economy.

There is no conceivable Kyoto-inspired strategy to dial fossil fuels out of our economy yet still continue the economic trends we have so highly praised and collectively enjoyed in recent years.

References:

U.S. Department of Energy, Energy Information Administration, Annual Energy Review, 1998.

National Environmental Education and Training Foundation survey, Roper Starch, November 1998.

Schlesinger, J.M., As energy prices continue to plunge U.S., sees a benefit in lower inflation, Wall Street Journal, 12/2/98.