Friday, June 06, 2008

Can the Market Solve the Energy Shortage/Peak Oil Crisis?

Readers Journal update--great commentaries on great topics.

As oil jumps back to $135/barrel the Wall Street Journal is reporting IEA Calls for 'Energy Revolution' To Reduce Fossil-Fuel Dependence:

The world needs to invest $45 trillion in energy in coming decades, build some 1,400 nuclear power plants and vastly expand wind power in order to halve greenhouse gas emissions by 2050, according to an energy study released Friday.

The report by the Paris-based International Energy Agency envisions an "energy revolution" that would greatly reduce the world's dependence on fossil fuels while maintaining steady economic growth. $45 trillion is a lot of money--almost four times the entire GDP of the U.S. and greater than the global GDP. Nonetheless, it is a "do-able" investment over a decade or two if funds were diverted from other investments/resources.

Let's cut to the critical issues here: will the market (i.e. private investment freely made without government subsidies) pony up the $45 trillion to reap the vast rewards/profits? Or are there unintended problems and consequences in expecting private capital to dredge up and risk the $45 trillion?

Let's start with ideological bias. Many if not most of the readers of this site are fundamentally libertarian in their POV (point of view), as am I (no surprise there, eh?). I would describe this POV as being skeptical of government "solutions" which are impervious to market and citizen-based forces--which by its very nature, is most of government.

For instance, how are we standard-issue citizens supposed to know if the $40 billion being spent on the Joint Strike Fighter is the smallest possible amount, or if it is largely monumental waste imposed by arcane policies only a few understand? If our property taxes were doubled and local government was "saved" from making hard choices by this massive influx of revenues, would even one cent of those billions ever be returned to taxpayers as "unnecessary"? (Please don't hurt yourself from laughing too hard.)

Cities like Vallejo, which recently declared bankruptcy, are being pillaged by public employees who game the system to reap overtime and other pay in excess of $200,000 each; we taxpayers know that "saving" Vallejo with additional millions would have simply encouraged more public employees to game themselves into the elite gorging at the trough.

(And please don't insult us by saying salaries and overtime above $200K are "saving the taxpayers money." Why not kill your parents and then plead for mercy as an orphan, too?)
The Libertarian POV is also skeptical of government intervention and policing of our private lives and decisions, such as what occurs in our bedrooms and with our bodies. We don't trust governmental spying and oversight because we are keenly aware of how bureaucratic inertia and "mission creep" can so easily lead to 300 million dossiers filled with factual errors and political "crimes."

(Cut to the scene in the film Casablanca in which the Nazi Major Strasser is reading aloud from his notebook dossier about Richard Blaine, a.k.a. Rick, played by Humphrey Bogart. Bogart snatches the notebook from the Nazi, glances at it and wryly asks, "Are my eyes really brown"?)

The right-wing, on the other hand, is intensely interested in mandating a variety of "moral behaviors" on everyone and in using tax funds for their ideologically-based pet projects, while the left-wing has never seen a taxpayer-funded social program it didn't like. The supply of victims of injustice and suffering are indeed endless, as are the lawsuits. And so we have obese plaintiffs suing airlines because the seats are too small: yet another class of hapless "victims" being needlessly tortured and flayed by ruthless cost-cutting corporations who need to be slapped down and managed by a benevolent caring government. (heh)

The libertarian in us observes that larger seats are already available: just pony up the bucks for a business or first-class seat if you need more space. Or take the train or ship or drive if you feel cramped. Libertarians would note that the average weight and bulk of Americans has skyrocketed even as their average height has dropped. Getting too big to fit in an airline seat is a choice, not a mandate to sue the airlines for "relief."

But Libertarians also have an ideological bias which is often manifested as a near-religious belief in the efficacy of the free market.

Before you start that email flaying me alive, consider this anecdote. About 15 years ago, just prior to the lift-off of the housing bubble, I was invited to join a focus group of other "consumers" (not housing experts or academics) on the design and construction of "The American Dream Home," a house which was to be built as part of a joint newspaper/builder promotion.

The focus group was supposed to "start fresh" with what constituted "The American Dream Home," and perhaps unsurprisingly it turned out to resemble a McMansion of the sort which is now being abandoned by tens of thousands of bubble-bust homeowners.

How did it happen that people ended up at the same point the builders had set as the standard? The reason is that the market is circular. If all you know is a suburban McMansion with a big entry and a Great Room, and this is what's touted in every "home magazine" you've ever seen, then that's what you conclude is "dreamy."

If you've never seen a Usonian-inspired house (based on Frank Lloyd Wright's modest home designs), then how can you possibly choose that over a bloated McMansion? And since a Usonian house is small (and thus not as profitable as a larger house) and doesn't require much furniture (much is built in) or carpets and all the consumerist gew-gaws that fill up a Mcmansion and the glossy ad pages of the home magazines, then the media coverage of "alternatives" is inherently limited by market forces, too. Why run features which don't support your advertisers?

And how do the builders choose their designs? By asking consumers what they want. "The market" constructs entirely circular structures of "want/dream" and "product."

If we scrape away ideological purity/bias, we also have to deal with the fact that government ownership and policy are built into our society and economy.

Consider, for example, bike lanes. The government owns the streets and right-of-ways. Can a private investor/firm buy the right-of-way in order to build a toll bike lane? No. Only the government can create a bicycle lane, and it would do so as a political policy or decision.

Why choose a bike lane as a example? It's called "choice architecture." If there's no safe way to bicycle to work or downtown or to the park, then guess what, few people will choose to do so. And since there's no money in it--how to make a fortune building bike lanes is not on any venture capitalists' desks--it won't happen except as a policy decision.

If the policy creates a new "choice architecture" by providing a safe, enjoyable way to ride a bike, then perhaps people might well choose to try it out.

Meanwhile, naysayers can point to the few riders now on busy, dangerous streets and proclaim that "Americans will never ride bicycles, see?" But the truth is most Americans haven't been given a choice.

The government also retains policy control of zoning and land use regulations. The market responds to the "choice architecture" defined by these policies.

Tax policies also act as "choice architecture." How did we get distant exurbs which require long, energy-inefficient and time-wasting commutes? Rural counties willingly provided the infrastructure for new subdivisions in order to get the tax revenues from higher property values, and they also charged next to nothing for permits, and issued them over the counter in short order.

Meanwhile, the urban centers were charging developers $20,000 per unit for sewer permits--"make the private developers pay their fair share," went the argument-- and zoning restrictions limited density even as misguided preservationists made every developer pass through a costly and grueling process of proving the existing dilapidated structure had no possible historic value. Gotcha! This shack once housed the Boy Scouts regional headquarters! You can't touch it!

As these costs and obstructions piled up, housing supply dried up in urban centers and as a result, prices of the existing urban housing went up accordingly, even as prime orchards were cut down and "affordable" housing was built 40, 50, 60 or even 100 miles from job centers.
This sprawl was the result of pernicious policy choice architecture, not the market per se.

So as we look to replacing high-energy density petroleum with alternative sources, we have to ask: what is the choice architecture? What choices have current tax/land-use/environmental policies pare away/dropped as possibilities? What has policy set as the "default settings" which the market will default to?

The market has another massive inherent weakness: the cost-benefit analysis is limited and short-term. Should limited tax revenues be spent on a costly bike-lane which links housing to job and educational centers? The arguments against it are many: everybody drives, so why should we subsidize a handful of health freaks? The weather is lousy in winter, so the bike lanes can only be used half the year; Americans don't bike now (never mind getting killed on roads with no room for bikes is a real danger) so they won't ever bike, etc.

Meanwhile we as a nation are getting fatter and more unhealthy by the day. Medical care, much of it for chronic preventable diseases, already consume 16% of our GDP and if current trends continue, that will climb to 25% in a few years, paring away choices such as lower taxes and lower government borrowing.

If 1% of the populace rode a bike regularly and thus improved their chances of avoiding preventable diseases by some percentage, would that justify the "choice architecture" of providing a safe, enjoyable-to-use bike lane? How about a 1% decline in petroleum use as bicyclists didn't drive? How about a 1% reduction in traffic congestion? How about the life-cycle costs of a Prius (immense amounts of energy and resources are needed to make a Prius) versus a 35-pound bicycle which requires no fuel and almost no energy/resources to manufacture and maintain?

At what point will "the market" recognize or account for these benefits? Never. This is what is described in Garrett Hardin's seminal "Tragedy of the Commons." The common environment--the air, land, etc.--can be squandered privately because there is no cost to individuals consuming those resources. The "common good"--the reduction in air pollution, the improved health and lower future healthcare costs, the improved mental health of the bicyclists (endorphins flowing from exercise, reduced fatigue and depression, etc. etc.) , the conservation of petroleum for better uses, the reduced traffic, the time saved not sitting in traffic, the reduction of energy needed to build another Prius, all of these benefits are ignored by the market.

To return to our starting question: Can the Market Solve the Energy Shortage/Peak Oil Crisis? Clearly, the answer partly depends on the choice architecture set by government policies, and the choice architecture established by a bought-and-paid-for mass media which is largely controlled by five or six global media groups.

Recall that this is a circular structure: if the consumer is fundamentally given a choice architecture based on a distant McMansion, a car and a long commute, then he/she will be demanding some less-costly-to-fuel car and more lanes to speed the commute.

When building permits are nearly free and easy to get in urban zones, and costly and arduous in rural exurbs, then builders will flock to urban zones. When bike lanes are safe and fun and convenient, more people will ride bikes to school and work and shopping. If solar and wind power plants are fast-tracked and government runs the new power lines needed to reach them, then more will get built when electricity prices rise to the point of profitability. (Which is happening as I type.)

If investors can make $100 trillion in profits in a few years, then the $45 trillion will appear--but only if the choice architecture enables it.

There will be unintended consequences, of course. For instance: the U.S. budget and current-account deficits absorb about 80% of global savings. If those funds were diverted to earn a hefty return on alternative energy, then nobody would buy low-return T-bills or other U.S. debt.
In other words, if you can earn a 20% relatively risk-free return on, why would you buy a bond paying 3%? Maybe you'd be tempted if the bond paid, say, 15%. Guess what happens to housing and government borrowing when global interest rates double or triple.

I think it is safe to say there won't be enough private money generated over the next 20 years to lend the U.S. $1 trillion a year to squander and also fund $45 trillion in alternative energy.
But that's another entry.

Thank you, Cheryl A. ($25), for your unexpected and very generous donation via mail of the book The Great Wave by David Hackett Fischer. I am greatly honored by your support and readership.

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