Taking Charge of Oil Policy [Carbonomics, Ch. 2]
December 30th, 2006 by Steven Stoft, BerkeleyOPEC’s recent “energy policy” is a lot like a Kyoto policy focused on oil, but with a startling difference.
[...] Before the 1973 oil embargo, the United States spent under 2 percent of its GDP on oil. Then for a few years it spent 4 percent, and then in 1981 the cost spiked to 7.4 percent, and the world took oil prices seriously. By the end of 1985, OPEC was crushed by world-wide conservation, and for eighteen years, up until 2004, the United States again spent, on average, under 2 percent of GDP on oil.
During the eighteen-year grace period, and especially in the 1986, there were two points of view. Some said to keep the price high, keep conserving, and keep OPEC at bay. Others said they were liking the low prices. “Liking low prices” won out.
Keeping prices low had the predicted effect; conservation wore off, though not completely. Meanwhile, OPEC was wisely making very few new investments in supply capacity and waiting for world oil use to grow. It has grown, and prices are back up. The United States is now spending 4 percent of GDP on oil up from 1.7 percent in 2001. OPEC’s recent “energy policy” is a lot like a Kyoto policy focused on oil, but with a startling difference.
In 1998 DOE concluded that the United States, to comply with the Kyoto treaty, would need to push the price of gasoline up to $2.31 per gallon (2007 dollars). Similarly MIT found that a price of $70 per barrel of oil was sufficient up through 2025. In other words oil and gas are costing more now than if we had complied with Kyoto or something even stricter.
DOE’s Conclusion: Kyoto Compliance Would Reduce the Price of Oil
“Because of lower petroleum demand in the United States and in other developed countries that are committed to reducing emissions under the Kyoto Protocol, world oil prices are lower by between 4 and 16 percent in 2010, relative to the reference case price of $20.77 per barrel.”
The 16 percent value is for full compliance and the 4 to 16 percent range in oil-price reduction indicates that U.S. compliance has the dominant effect on world oil prices.
But that’s not the difference I’m talking about. To see the real difference, follow the money. DOE assumed the revenues from the tax on oil would be returned “to consumers through a personal income tax lump sum rebate.” In other words all of the higher gas costs of a Kyoto policy would have been returned to you and me with an annual check from the government [...]. That’s the difference.
There is no doubt that paying OPEC is worse than paying ourselves, but with a Kyoto-style policy, wouldn’t we have had to pay both at once? The answer is “No” for two reasons. First, gasoline prices only need to be just so high for conservation purposes, say $3.00 per gallon. To the extent OPEC raises the price, we don’t need to. Second, if we raise the price of oil first, that curbs oil use and makes it hard for OPEC to raise the price.
A Kyoto policy initiated in 1998 would have preempted OPEC by six years. DOE estimated that a Kyoto policy could have cut OPEC’s prices 16 percent, but DOE’s policy was focused on coal, and had no fuel economy measures. With a stronger focus on oil, OPEC’s price could have been reduced more. Also, DOE did not anticipate such a tight oil market, and when the market is tight, an oil conservation policy has more impact on price.
DOE is not alone in predicting that climate and independence policies will reduce OPEC’s price. For example, MIT’s model predicts a 47 percent reduction in the world oil price by 2050, and others have made similar predictions. This is because the idea that reducing demand reduces prices dates back to Adam Smith. That’s just how markets work, even when part of the market is controlled by a cartel. [...]
Steve Stoft
These are excerpts from Chapter 2 of my forthcoming book Carbonomics.