Here’s how Campbell puts it.

“A decline in the supply of cheap oil-based energy will have an unavoidable and far-reaching impact on the economic prosperity of the World. It may on the other hand have a positive impact on the environment generally. For example, climate change concerns might evaporate.” —C. J. Campbell, 2003.

Now don’t get me wrong. These guys are geologists, and I’m not; so for all I know, they could be exactly right about how much oil is in the ground. But one things puzzles me. Their analysis, as they claim, is pure geology. But their prediction is about “oil production,” and pumping oil is not a geological process. This is not just a matter of rock science. In fact they seem to have overlooked a rather important factor in oil production—money. Any theory of oil production that ignores money just could be off kilter.

The End of the World is Nigh (How Peak Oil Solves Global Warming)

Richard C. Duncan, the third most popular Peak-Oil prophet on the web, and an electrical engineer, has done a great service by providing a graphical representation of the peak-oil hunch, which he calls the “Olduvai Theory” of energy, population and industrial civilization. As shown in the illustration above, total energy per capita will drop sharply after 2008. According to the theory, “world population peaks at 6.9 billion circa 2015, and thereafter declines to 2.0 billion in 2050.” In the process 4.9 billion people die for lack of oil.

Now it should be admitted that these geologists actually do think about money, and this is their theory of economics: “There is no way spending money can make more oil appear underground.” Brilliant. But economists are still puzzled. They believe that those with the most money at stake make the best predictions and so they watch what those people do. Saudi Aramco, Exxon, BP, and the other big oil companies have plenty at stake and hire the worlds best experts. They are not acting like the world is coming to the end of oil.

In 2007 oil is worth about $65 per barrel, but Olduvai theory says ten years later people will be dying like flies due to an oil shortage. What will the price be then? Surely people would pay $10 a gallon for gasoline, and surely the oil companies would charge that much. That’s about $440 per barrel of oil, which is seven times more than now. So here’s the catch. By keeping the oil in the ground, they could earn an 83% rate of return on their oil for the next 10 years. That’s more than fabulous; that’s unheard of. No one would sell oil now, if they could make that much money by keeping it in the ground. But instead, all of them are producing as fast as they can. Economists conclude that those with their money on the table, who have hired the best teams of experts and have access to the most private data, don’t believe the peak-oil geologists.

But let’s assume the peak oil crowd is completely right about the “geology” of oil production. What then? Will we die like flies or will we fight back? People spend about a trillion dollars a year driving, and if you charged them three times the current price they would mostly pay it rather than stop driving. They would not be happy, but there would be three trillion dollars available to whoever found an oil substitute. After a few years that begins to add up.

But is technology up to the challenge? Can it make gasoline out of something besides oil, and is there enough of that something to power a billion automobiles? Sounds like a tall order. But the strangest part of the whole peak-oil nonsense is this. The answer was discovered 80 years ago and is well known to every one of the leading lights of peak oil. The answer is coal and the Fischer-Tropsch process of turning it into gasoline.

This is not a theory; this is what powered the German Luftwaffe during WWII, and much of South Africa when their oil was embargoed. In 1938 Germany consumed 44 million barrels of oil of which 10 million barrels was synfuel from coal. By 1943 their synfuel output had increased to 36 million barrels. That was their response to an oil shortage.

Of course, the process has been much refined, and today Montana could produce gasoline for the equivalent of about $55 per barrel of oil. This has not yet happened because investors are afraid the price of oil will fall back below $55 as soon as they build a coal-to-gasoline plant. Last time oil was this expensive, the price did drop back to $20/barrel for a decade, so their fears are justified. But if we start running out of oil, they would know the price would not drop back below $55, and would build synfuel plants just like the Germans did sixty years ago.

Making gasoline is possible, but is there enough coal? Deffeyes assures us that “Worldwide coal reserves are large enough to continue present rates of production for a few hundred years.” Since world coal production provides two thirds as much energy as world oil production, that’s enough to get by for quite some time. Deffeyes (the Princeton geologist) has now realized that this is what will happen if oil runs out. The last sentence in the coal chapter of his second peak-oil book reads as follows:

“I hate to say it, but we likely will be forced to choose either increased pollution from coal or doing without a significant portion of our present-day energy supply”. —Kenneth S. Deffeyes, Beyond Oil, 2005.

I congratulate him for being the first peak-oil expert to name the real dilemma. What he must also know is which option we would choose. The world will not seriously curtail its driving habits but will choose instead, without blinking an eye, “increased pollution from coal.” There is no energy shortage in this century, and we will not be saved from climate change by running out of oil. Coal will again be king, and its high ratio of carbon to energy will hasten global warming.

[...] Unfortunately, those interested in one challenge generally have little interest in—and sometimes have antagonism towards—the other. My position is that the two challenges are not only compatible, but that solving either requires solving both.

Twin global challenges. Global warming requires a global solution, but [...] energy security also requires a global solution. In 1974, the United States recognized the need for a global response to OPEC, and Secretary of State Henry Kissinger organized what the New York Times called “A counter-cartel of the major oil-consuming countries.” That organization, the International Energy Agency (IEA), still exists and includes 27 countries. But it has forgotten its original purpose.

In 1979, after OPEC doubled oil prices again, the seven industrialized nations held a “world economic summit.” They issued a communiqué, which the New York Times again said “amounts to a consumers’ cartel.” This effort also fell apart; nevertheless, the global response to high oil prices eventually did crush OPEC—but not for good.
Now [...] people think the United States can achieve energy security on its own. But, even if Americans cut oil imports to zero—say by driving hybrid cars that drink ethanol—we would not achieve independence. The price paid at the pump for American corn ethanol would still be controlled by the global oil market—just as that market now controls the price of ethanol. Of course we will not cut oil imports to zero for decades, and independence will remain a doubly global problem. Imported oil will be insecure and domestic fuels will be subject to global price shocks.

So America faces twin global challenges, climate stability and energy security. Both are dangerous. OPEC’s market share is rising again as it did before 1973, and OPEC is again short on production capacity. China and India are rapidly expanding their demand for oil. Greenhouse gases are increasing faster than ever and China has passed the United States and is the largest emitter of CO2. No one country, not even America, can meet either challenge on its own.

By curbing our use of oil we could force down its price on the world market. This makes some sense, but the job is much harder if we go it alone. First, any price decrease we cause will benefit all consumers worldwide. Second, those other consumers will take advantage of the lower price to use more oil—partly counteracting our effort to reduce oil use and the price of oil.

Climate change presents a parallel problem. No country, acting alone, can do much to stop climate change. Any country that tries will find that most of the benefit accrues to other countries. The more we do to reduce global warming on our own, the less others will worry about global warming, and the less they are likely to do.

Economists call these problems free-rider problems, because when someone helps out, others take advantage and go for a free ride. Both challenges are global in nature, both require global solutions, and both are plagued by the free-rider problem. They are not identical twins, but they have much in common besides an addiction to oil.

Although the twin challenges are closely related, some proposed solutions that help with one challenge conflict with the other. Joint solutions, however, help with both challenges. One proposed solution for energy independence conflicts with climate change most intensely. Unfortunately it is the favorite of Big Oil and Big Coal.

Coal companies like the idea of making gasoline from coal for obvious reasons—it takes a lot of coal. But oil companies are just as enthusiastic because they would build and operate the coal refineries. The problem is, these refineries use far more fossil energy than oil refineries, which is terrible from a global-warming perspective.
Fortunately, conservation, the main activity that crushed OPEC in the early 1980s, is an ideal solution for both challenges. In fact, conservation is also much better for energy security than producing gasoline from coal. Of course, the oil companies hate conservation—shorthand for not using their product. Gasoline made from coal keeps us addicted and keeps us paying prices that are determined by the world oil market. Conservation helps break the habit.

The chance of achieving a sound energy policy is now better than ever, because we have a double motivation. OPEC is again breathing down our necks, and climate change has become the number one national concern on the ecology front. But there are two camps in America, with relatively little overlap. One sees the problem of energy security and the other sees the problem of climate stability. If one camp adopts a policy that conflicts with the goal of the other camp, the double motivation will provide no benefit, and the two camps could cancel each other out.

On the other hand, adopting a cooperative strategy could produce a complementary alliance between the two groups. The ecology camp could provide the staying power and the link to popular international concern about energy issues that the energy security camp is lacking. The energy security camp could provide the motivation that comes from the short-term tangible gain that is possible in the oil market. It took only about six years to bring about a huge reduction in world oil prices after OPEC doubled oil prices in 1979-80. It will take much longer to have any impact on climate change. [...]

Steve Stoft

These are excerpts from the introduction (Chapter 1) of my forthcoming book Carbonomics. You can read and download the entire chapter at http://stoft.com/p/carbonomics.html

[...] 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.

[They were too much influenced by Mad Max movies.] Starting in 1979, the Mad Max film trilogy painted a bleak and violent picture of a world plagued by oil shortages that cause a nuclear war. Since then, predictions of a similarly grim economic future have become attached to peak-oil theory.

Peak-oil’s Mad Max economics assumes markets work like this:

The demand for oil increases as wealth and population increase. The supply of oil will fall after peak oil. Therefore supply will not meet demand, and a crisis will destroy the world economy.

However, that is confused economics. Basic economics predicts that unless the government interferes, markets will work like this: The demand for oil increases as wealth and population increase. The supply of oil will fall after peak oil. Falling supply will cause the price to rise, and that will cause people to use less. Demand for oil will fall until it equals supply.

That is what happened in the early 1980s. Deffeyes, the Princeton geologist, knows both theories and explains in his book Beyond Oil why he thinks basic economics is wrong. “For the first time since the Industrial Revolution,” he begins, “the geological supply of an essential resource will not meet the demand.”

This is partly right. Markets have worked for all essential resources. But Deffeyes is worried that the law of supply and demand is about to break down for the first time in 250 years. Other peak-oil proponents blame this breakdown on markets, but Deffeyes, remembers the real reason: “Virtually all economists visualize it as price increases that bring supply and demand into a new equilibrium.” Exactly. By equilibrium he just means supply equals demand. But after remembering the reason, he rejects it.

“That outlook is widespread,” Deffeyes says. “It must be something that Gerber puts in baby food.” He doesn’t believe that price will do the job. Instead, he has another theory, which he supports with two examples from history:

• “Historically, President Nixon regulated the oil price.”
• “President Roosevelt had us carrying little red and blue gasoline ration coupons.”

Deffeyes is right that, if the government intervenes, it can break the market and then demand will fail to equal supply. According to Deffeyes, this is why, after 250 years, the market for oil will break down when oil production peaks.

Deffeyes argues that the government will intervene because “when the situation gets serious, there will be immense political pressure to ‘do something.’” But Deffeyes overlooks what happened after Richard Nixon regulated the price of oil. By the end of the OPEC crisis, virtually the entire elaborate system of oil-price controls, gasoline-price controls, and quantity rationing had been eliminated. This took immense political wrangling, but eventually there was widespread agreement. The country learned something back then, and I don’t think it’s about to forget it and cause the collapse of the American economy—or the world economy. [...]

Steve Stoft

These are excerpts from chapter 3 of my forthcoming book Carbonomics.

Organizing is slow but cheap. The trick to making real progress is to get past the organizing stage so that action becomes effective. The trick to getting organized is to postpone the discussion of how stringent the policy should be until after the organization and policies have been put in place. That means designing the policy around an easy-to-live-with cap or incentive that can easily be made stronger once the policy is agreed on.

This approach is opposite to what happened with the Kyoto protocol. At Kyoto most of the effort went into arguing about how strict the caps would be. But because China, India, Brazil, Australia and the United States were unhappy with the caps they rejected the policy itself. Third world countries signed on, but only after they got exemptions from the limits—in other words from the fundamental policy. Nothing was required of them. In the end, there was little cooperation, the policy was weak, and compliance was spotty at best.

The result of this failure is that fifteen years after the world started to organize, CO2 is being emitted 25 percent faster than in 1992 when the U.N. started the process, and the rate of emissions growth has accelerated in recent years. The organization process is now starting over, with not all that much to show for the last fifteen years.

The IPCC estimated global temperature change through the year 2100 based on six “equally sound” emission scenarios. The graph shows three of these, and the bars at the right show all six. The lowest line on the graph shows what would happen if greenhouse gas concentrations stopped increasing in 2000.

Climate science has spoken [see figure above]. There is more than enough reason to organize a global policy that it capable of sustaining and even enforcing effective emission controls. With stringency and costs set low at the start, there is no excuse for anything short of “full speed ahead.” Once the organization is in place, the science will be clearer. Assuming the climate is changing as it now appears to be, that will make setting stricter limits or stronger incentives easier than it is now.

Steve Stoft

These are excerpts from chapter 4 of my forthcoming book Carbonomics.

In the early days of the first OPEC crisis, physicists vigorously advocated conservation as the primary defense against OPEC. They claimed it was cheaper than increasing the supply of oil and sometimes cheaper than free. For example, insulation might save more in fuel costs than it cost to insulate [...]. In spite of lacking a degree in physics, Amory Lovins is perhaps the best-known member of what I call the physics camp–though he never did earn his degree in physics.

[…] Without question, the physicists were right about conservation’s importance. And they were right that, as Lovins puts it, conservation does not have to mean “discomfort or privation (doing less, worse or without).” Most of the physics camp, and many economists, agree that some conservation measures are cheaper than free. But Lovins goes further and claims that everything we need in the way of energy policy is cheaper than free. Is he right about this?

As with peak oil, we can look to history to evaluate claims that conservation will be cheaper than free. In his 1990 article, Lovins predicted that four “revolutions” in electric efficiency would greatly accelerate the conservation of electricity. The revolutions were:

1. Technical Progress. For example, better light bulbs.
2. Markets for “negawatts.” Negawatts are watts of electricity not used.
3. Cultural change inside utilities. For example, learning that conservation is profitable.
4. Reforms in regulatory philosophy and practice. In particularly, “decoupling” profits from increased sales.

In short, Lovins predicted that by now we could be using almost no electricity—only about 3 percent of what we used in 1990—and that this conservation effort could save us, counting all costs, over two hundred billion dollars a year.[…].

Lovins’s starting point is that already in 1990, “the best technologies now on the market could save about 92 percent of U.S. lighting energy.” However for all electrical uses combined he claimed that only three quarters of the electricity used was unnecessary. Moreover, Lovins’s tells us that conserving that much would have cost eleven times less than using the saved electricity.

Next he claims that the cheaper-than-free opportunities had doubled in the previous five years, and would do so again in the next five and that he saw “no signs of this slowing down.” Better yet, the cost of conserving, would be decreased by three times every five years.

As it turned out, between 1990 and 2005, electricity use went up 34 percent, not down 97 percent.

The trouble with Lovins’s optimism is that it is not just a little optimism. It overwhelms all other approaches. It says we don’t need […] any government policies. All we need to do is […] keep an eye out for new efficient technologies that will save us money. New technology will crush OPEC, the coal industry and nuclear industry. Global warming will fade away.

Lovins is right to favor conservation, and right to favor the use of markets. Some of his ideas are practical. But three centuries of technical progress have brought unimaginable efficiency gains—and vastly increased use of fossil fuel—without solving our energy problems. Something more is needed than Lovins’s promise of “breakthrough engineering” […]. Lovins objectives are well intentioned, but his hyper-optimism is a barrier to almost every effective energy policy.

Steve Stoft

These are excerpts from chapter 5 of my forthcoming book Carbonomics.

Neoclassical economists say: the physics camp claims all its proposals are free lunches, but there’s no such thing. We need taxes. The physics camp says: call them free lunches if you like, but there are a lot of ways to save money and energy at the same time—who needs taxes?

[...] The two camps focus on two different problems. The price of fossil fuel is too low, so we need the neoclassical solution of higher price signals. Consumers are short sighted when evaluating future energy savings, so some efficiency standards can help them save money. Many if not most economists favor both approaches when each is used to solve the matching problem.

This compromise rejects the extreme neoclassical position of assuming perfectly rationale of consumers, but it also requires two changes in the tendencies of the physics camp. It requires taking fossil-fuel prices far more seriously and it requires backing away from the notion that physicists know how to fix literally hundreds of market imperfections while saving money.

I believe economists are right to be suspicious of large numbers of “market-fixing” efficiency regulations. Their skepticism is not based on an implausible assumption of consumer rationality, but on the four realistic concerns listed in the insert below, which are consistently ignored. Moreover the design of even major efficiency standards is poor and fails to use modern economic tools. This has resulted in such fiascoes as fuel economy standards that remained at their initial 1975 setting for over thirty years, and that reward designs that kill more people while using more fuel. I am referring to the requirement that cars be aggressively redesigned so they can be reclassified as trucks and qualify for a lower fuel efficiency.

Generally, claims that the programs will save more than they cost omit four considerations, each of which can be quite important:
Regulatory Inefficiencies. Neoclassicals assume perfectly efficient markets. Physicists implicitly assume perfectly efficient regulation. This bias is the result of omitting any cost for regulatory mistakes, such as setting a standard incorrectly. I have not found energy regulators to be any more rational than new car buyers.
The Take-Back Effect. When an appliance is made more efficient it often becomes cheaper and more convenient to use. Consequently people use it more or buy a bigger one. This is a benefit to society and actually makes efficiency programs more valuable than the physicists claim. But it also means efficient appliances use more energy than estimated.
Here’s how the evaluation of savings from compact fluorescent bulbs can go wrong. […]
• Replace a 40-watt incandescent bulb with a 100-watt-equivalent compact fluorescent lamp (CFL).
• The CFL uses 23 watts.
• The actual savings is 17 watts.
• CFL program evaluation assumes that when a 100-watt CFL is used, it replaces a 100-watt incandescent bulb (they can’t tell, so they make this guess).
• Replacing a 100-watt bulb with a 23-watt bulb saves 77 watts.
• Calculated savings: 77 watts. Actual savings: 17 watts.
In addition, because the light is cheaper, people may leave it on more, and the savings could actually be zero. This is an extreme case, but it happened in my kitchen. Most efficiency gains are not lost to the take-back effect—at least not right away.
Consumer Inconvenience. Some ways of gaining efficiency cost no money, but do cause inconvenience. For example, making the walls of a refrigerator thicker means it either takes more space in your kitchen or holds less food. The cost of such inconvenience is nearly always ignored.
Consumer Variability. If I run my air conditioner 1000 hours per year, any improvement in efficiency will be 100 times more valuable than if I run it 10 hours per year. It does not make sense for a low-use appliance owner to buy as much efficiency as a high-use owner. This means that even the best efficiency standard is likely to be a waste of money for the low-use owner. I have never seen this accounted for.
Although there are many imperfections in markets, that does not mean there are many free lunches. There’s only a free lunch if the problem can be fixed at a cost that is less than the savings. All four of the considerations just discussed either raise the cost of fixing the problem or reduce the benefit. Since they are generally ignored, the claims of free lunches are frequently overstated.

It would accomplish far more to design the major standards well and evaluate them carefully, rather than to charge ahead with hundreds of smaller measures that ignore economic concerns. But the real challenge for the physics camp is to accept the importance of price and to realize that their entire campaign is at risk without the proper price signals.

Having worked in the physics camp for years, I have heard many excuses for ignoring the take-back problem, but have never actually seen it taken into account. This is too bad because, if the problem were faced squarely, the natural conclusion would be that the neoclassicals’ price signals do not substitute for efficiency measures but rather are a necessary complement.

Think about the history of take-back. Ordinary bulbs are 150 times more efficient than candles. But we don’t uses 150 times less energy for light, we use more energy than in colonial times. Scientists of the past have provided us with enormous efficiency gains, but never enough to reverse our increasing use of energy and fossil fuel.

So the physicists are taking a real gamble. Compact fluorescent bulbs may save energy this year, but ten years from now, people may have discovered they can afford to light their gardens at night as brightly as the sun lights them in the daytime. And the less energy a light uses the less it pays to switch it off. If history is a guide, increasing wealth combined with the take-back effect will eventually win out over the energy savings of increased efficiency.

There is a simple way out of this dilemma. Raise the price of electricity, and refund the extra cost. […] The higher price of electricity reduces or reverses the take-back effect. The price increase should not be tied to the efficiency gain, but implementing the price signals of the economist greatly reduce the risks of take-back inherent in the physics approach.

The compromise then between the extreme neoclassical camp and the physics camp is simple and positive. The most important efficiency programs, especially fuel-economy standards, should be accepted and perfected. Neoclassical economists should stop arguing against these on the basis of untested theory.

The physics camp should recognize that there are real problems with “fixing” markets and that blind faith in regulatory fixes is no more appropriate than blind faith in markets. Physicists and economists should join forces to make the big efficiency programs work better, and on implementing better fossil-fuel prices. This will help protect the energy efficiency gains from the energy-consuming take-back effect [...]

Steve Stoft

These are excerpts from chapter 6 of my forthcoming book Carbonomics.

“Among policy wonks like me, there is a broad consensus. … if we want to reduce global emissions of carbon, we need a global carbon tax.” So said Mankiw, whom I disagreed with over fuel economy in the previous chapter. I agree completely with Mankiw, on this—the central point of his article in the New York Times. He also mentions that President Reagan’s chief economist, Martin S. Feldstein, a famous opponent of tax distortions, came up with the idea of using a carbon tax back in 1992.

As Mankiw says, there is no disagreement “between environmentalists and industrialists, or between Democrats and Republicans” on the benefits of a carbon tax. He’s right. A carbon tax is the cheapest way to solve the first, and most important, energy-market problem, “the missing cost of carbon emissions.”

But, as Mankiw also reminds us, both American voters and political consultants consider “tax” a four-letter word. Can we find a way around the political lightning rod of “taxes” to save Americans tens of billions of dollars a year by implementing the best economic policy?

Mankiw comes close to finding the way. There are two halves to any tax—how it is collected and how it is spent. The benefits of the carbon tax come entirely from the first half—the charges on carbon, which increase its price and make us all look for ways to avoid using fossil fuel. So economists look for ways the government can spend the tax revenues to make voters happy. Happy enough to forget it’s a tax? Not likely.

Mankiw proposes to spend the carbon tax revenues on a “rebate of the federal payroll tax on the first $3,660 of earnings for each worker.” That is close to the right answer. Others propose reducing income taxes either personal or corporate, and some propose spending it on research and subsidies.

To find the right answer, we must go north to Alaska, where the air is cold and heads are clear. The answer—how the government should spend the money—couldn’t be simpler. Don’t spend it! Just give it back to us, thank you very much. Alaska sends identical checks, for a little over $1000, to every Alaskan resident every June. It collects these revenues from its famous oil pipeline. This is popular. This is an untax.

Taxes raise money for the government. The office football pool collects money and gives it back. That’s not a tax. That’s an incentive to correctly predict the winning team. It’s also fun.

A carbon untax is an incentive to use less carbon. Use the average amount of carbon, and your refund check will exactly cover what you contribute to the carbon pool of money collected from oil, gas and coal companies. Your contribution will not always be obvious, but these companies will raise prices to cover their carbon charges. That’s exactly what’s needed to discourage the use of fossil fuel.

Use more carbon than average, say by flying your own personal jet, and you will pay more in higher fossil prices than you get back in June. Because the rich tend to use far more than average, 60 percent of us are actually below average, and will get back more in June than we pay the rest of the year in higher fossil prices. The less carbon you use, the greater your net winnings—or if you fly your own jet, the less you lose by. That’s why, even though it gives back all the money, the untax works perfectly.[…]

Some people will want to change the untax to pay down corporate taxes, while others will want to spend it on energy programs. Both of these options change the untax into a regular old we-hate-it tax. Let me make this as simple as possible:

• All economists know that a carbon tax or a carbon untax is best.
• If the government keeps the money, it’s a tax.
• If it’s a tax, you can forget it; it will never fly.
• It’s better for lawmakers to implement an untax than to grab for the revenues and get nothing.

Steve Stoft

These are excerpts from chapter 7 of my forthcoming book Carbonomics.

Market-driven conservation is a slow process—slow to get going and even slower to stop. Looking at recent high oil prices, people noticed that gasoline use was slightly higher in 2006 than in 2005, and many concluded that higher prices were not working to curb gas consumption. People thought the same in 1974, when the price of oil tripled and world oil consumption fell only 1 percent.

Market-driven conservation starts slowly because the best way to conserve is to switch to better technology. People don’t buy cars and refrigerators until they need new ones, and companies take years to design new, more efficient models. It wasn’t until 1980 that changes in technology began to pay off. But then world oil use took an unprecedented four-year nosedive (see Figure 1). Figure 1 also shows that people kept conserving after the oil price collapse. In fact, changes made in 1980 are still saving us oil, otherwise the price of oil would have hit $100 a barrel years ago.

Figure 1. The top line is projected world oil use without OPEC. The line that branches off below it in 1974 is actual world oil use. The difference is the amount of oil conserved because of OPEC’s high prices. Notice that changes made because of OPEC—things like fuel-economy standards and better insulation—are still saving an enormous amount of energy worldwide.

Jorgenson and Peter J. Wilcoxen, two of the best applied economists in the US, intensively studied the impact of the two oil shocks on the United States. They concluded that “over the period 1972–1987 U.S. emissions of carbon dioxide were stabilized by price-induced energy conservation.” Although carbon dioxide emissions worldwide did not stop increasing as they did in the United States, global emissions increased more slowly during the crisis.

The power of price lies in its ability to act in a million ways at once, many unexpected. Even when price directly affects people, they don’t always recognize it. For example, consumers upset with high gas prices in 1975 lobbied for Corporate Average Fuel Economy (CAFE) standards, federal regulations that require improved fuel efficiency in vehicles. These mileage standards continue to affect car buyers to the present day, but few recognize the role of OPEC’s high prices in bringing about these energy-saving measures. Many people also failed to notice that the collapse of OPEC’s price caused the freeze in mileage standards from 1985 until 2007. Lawmakers have revived increases in mileage standards only because oil prices have again risen for several years running. Even the energy gurus of the physics camp, who now push for stricter standards and ignore energy prices, owe their careers to OPEC’s high prices. I say this not to belittle their work, but to point out how fundamental and varied the price effect is. Price changes everything. And the whole world responded to OPEC’s high prices.

Figure 2. High oil prices lead to more exploration for oil and a greater supply of oil from non-OPEC countries. This is the cause of the “bump” in the non-OPEC oil-supply line between 1976 and 1993. The extra supply shown here is much less than the supply saved by conservation, shown in Figure 1.

As Figure 2 shows, high prices also lead to increased supply. New oil supply generally requires new wells, and these take time to develop. As you can see in the graph, it took about five years after the first major price increase for supply to increase noticeably, and it took about seven years after prices declined, until 1993, for the extra supply to evaporate. The extra non-OPEC oil supply over the years did not total up to even one extra year of oil supply measured at the 2006 level. On the other hand, conservation provided us with the equivalent of eight or more years’ worth of extra oil (see Figure 1).

Conservation gave us ten times more bang for the OPEC buck than increased supply. Even today, the leftover conservation measures from the 1974 to 1985 OPEC crisis are doing more for us than the extra supply did at its peak in 1985.

Steve Stoft

These are excerpts from chapter 8 of my forthcoming book Carbonomics.

The world oil market controls the price you pay for gas at your neighborhood gas station. Taxes, gas station profits, and oil-refinery profits also take their toll, but when you see the price of gas go up twenty cents in one week, that’s the world oil market in action. There’s no escaping it. Even if your gas station sells gasoline made from 100 percent American oil, the price goes up exactly the same amount. Even if you buy American corn ethanol, the world oil market hits you just as hard.

This spells bad news for the most popular path to energy independence: alternative fuels. But [...] the world oil market treats conservation more kindly.

[...] “Liquid fuel” includes alternative fuels, not just oil, because the oil market extends to all liquid fuels that can substitute for each other in the transportation system. They don’t have to be perfect substitutes; it just has to be fairly cheap to use one in place of the other.

For example, it’s easy to use more ethanol and less gasoline, or vice versa. Anytime two fuels are good substitutes for each other, their prices are closely tied together, so we can think of them simply as part of the world liquid-fuel market.

[...] We can produce more liquid fuel by converting corn to ethanol, converting soybeans to diesel, drilling for oil in Alaska’s Arctic National Wildlife Refuge, or converting coal to gasoline. The future will bring even more options—some better, some worse. The alternatives have different costs and different pros and cons. To the oil companies, alternative fuels means liquid coal, shale oil, and oil from federally restricted areas. To environmentalists, alternative fuels are renewable biofuels. From an energy-security perspective, alternative fuels are all the same, even though they differ sharply in their effects on global warming.

President George W. Bush promised that we will be making 35 billion gallons of alternative fuels by 2017. So you might think we are well on our way to energy independence and are at least partly protected from the next OPEC oil shock. Unfortunately, even with that much ethanol, an oil shock would hit U.S. drivers just as hard as it would without the extra fuel. But there would be one big difference: The alternative-fuel producers would make a killing. They would sell each of those 35 billion gallons of ethanol for exactly the same price as OPEC-based gasoline and pocket the price increase as profits. That’s how the world market works.

This is not just a theory. We produce almost half our gasoline domestically, and the cost of producing that gasoline doesn’t change at all when OPEC raises the price of oil. But when the world oil price increases, so does the retail price of all gasoline, whether it is made from domestic oil or foreign oil. You don’t find low-price gas stations selling domestic gasoline. You won’t find low-price domestic ethanol stations or low-price domestic liquid-coal stations either. As we’ve seen, all liquid-fuel prices move together.

So is the produce-more strategy just a hoax? Not quite. It helps in two ways. First, producing more (or consuming less) helps reduce the world price of oil. Producing 35 billion gallons of ethanol could reduce the world price of oil by 2 or 3 percent. Second, it means some of our gasoline dollars that would otherwise flow to OPEC or Canada will instead flow to the American or semi-American companies that make the extra liquid fuel. I say semi-American because Archer Daniels Midland, the biggest ethanol producer, as well as the big oil companies are all multinationals.

So if terrorists blow up a Saudi oil field, alternative fuels will provide no protection for American consumers. If we are using lots of American-made alternative fuel, alternative-fuel companies will make a killing off the oil price shock by charging American consumers the world price of oil.

[...] Rather than producing more domestic oil or biofuels the path to independence is to consume less. The math on this approach is simple. If your car uses half as much gasoline, you are hit half as hard by an oil price shock. If your car uses the same amount of fuel but a different kind, you are hit just as hard. All liquid fuels change price together. Conservation provides protection that alternative fuels fail to provide.
Replacing a gallon of gasoline with corn ethanol and conserving a gallon of gasoline both reduce oil use by about the same amount. Conserving that gallon saves slightly more oil because alternative fuels, such as ethanol, use a little gasoline in the making. So conservation reduces imports slightly more than the use of alternative fuel and lowers the world oil price slightly more.

[...] In previous posts, I discussed two reasons why conservation is the best strategy: It is available more quickly than increased supply, and it saves more than increased supply can replace. Here I add a third reason why conservation dominates: It protects consumers from oil price shocks, something an increased supply does not do.

Steve Stoft

These are excerpts from chapter 9 of my forthcoming book Carbonomics.