Economics and Energy

Economics and Energy

I often hear that we are running out of energy or we need renewable or clean energy. While I am sympathetic to the emotion and would love a system of clean renewable energy I am also a realist. In our energy dense economy and given our standard of living that has been enabled by our use of energy there is not a lot I would give up to get to a fossil fuel free world.

Let’s face it, the drive to a “renewable” energy future is based on the notion that we will run out of fossil fuels, fossil fuels are dirty and that the government should intervene in the market for our own good.

I am not an economist. I do, however, understand supply and demand and that economic concept in a free society means everyone responds in their own best interests to market realities. Those realities mean that oil drillers will search for oil or natural gas and coal mining companies will search for and dig coal as long as the revenue produced is enough to offset the cost of production and produce a reasonable profit for the stockholders. You and I will buy their oil, gas or coal or the power produced from it as long as we perceive the price to be worth giving up our money for. Is it worth paying for that electric to have air conditioning in my house? Yes, so far. Is it worth paying for that natural gas so I will have heat and hot showers. Yes, so far. Is it worth paying $4.00/ gallon and getting 20 mpg to travel for my work? Yes, so far. What about using the electric stove or my coffeemaker or charging my cell phones or the TV or VCR or lights after dark or the blender for my smoothies or my computer and laptop and kindle? Yes, so far. We all trade money, which we value, for stuff we value more. And we all make choices every day about what we value more. Do I trade my money for $12.00/lb Filet Minion or $3.99/lb pot roast? Do I buy the $5.00 bottle of wine or the $50.00 bottle?

Energy is a commodity and as such is priced by worldwide demand. As demand increase and supply stays the same the price necessarily increase because more people (customers) are chasing the same supply. If you own a commodity do you sell it for $75.00 if someone will pay $100.00. Nope. The reverse is also true as we have seen in Natural Gas. Large increases in supply from the Marcellus and Utica Shale plays have driven the price down.

Now, with this basic economics in mind will we run out of fossil fuels? Let’s look at it. As the supply declines then the price will necessarily go up as customers who need the fuel will bid up the price. As prices go up, two things happen. 1) there is more of an incentive to look for more where it hasn’t previously been economical to look and 2) people will cut back on uses of fuel that they don’t deem economical ie buy smaller cars, set the thermostat warmer in summer and cooler in winter etc etc. This actually mitigates the price rise until continued higher demand stabilizes prices at the higher rate. The other thing that happens is that the alternatives to traditional fuels begin to look better. If coal fired electric is at $.10/KWH as mine is and Wind Generated electric is $.40/kwh, which one do I choose? If coal goes to $.40/kwh then I would choose Wind. Until then I’ll use coal.

My point here is that the market will decide. The best thing to cure high prices is high prices. Higher fossil fuels costs not only will discourage demand but will encourage lots of alternatives. Artificially raising prices by fiat or regulation or tax credits ultimately will fail because the market is the market. People will find ways around the regulations or the economics just don’t work. Entrepreneurs and innovators have been finding better ways to do things for centuries. That innovation is driven by self-interest.