Thursday, April 03, 2008

Why $100+/Barrel Oil is Good

A lot of people are complaining about the high price of oil lately. Frankly, I don't have a ton of sympathy. Oil has been quite cheap - artificially so, in my opinion - for a long time; for once it feels like it is finally priced at something that captures it's true cost. It shouldn't surprise anybody that oil is expensive. After all, it is a finite resource in a world of increasing demand and all the "easy" sources have been drained so each incremental barrel is more difficult to find and extract. I can't say whether or not $102 (today's closing price) per barrel is the "right" price (although markets tend to be pretty good at finding the"right" price), but it's probably in the right ballpark and I don't see it going down anytime soon.

Our entire economy is dependent on oil, so how can expensive oil possibly be a good thing? As a country, we've been moaning for a long time about our "addiction to foreign oil" and talking about things like "energy independence." And usually when politicians say it, they are frustrated about their inability to do anything about it. Well, of course they're frustrated: economies respond to market forces, not government dictates. We haven't weaned ourself from foreign oil because it's been so cheap compared to other energy sources. The only way a government can alter our course is to alter that dynamic, typically through things like tax policy, which is often quite dangerous to political careers (even if it is the right thing to do). And besides, no rational government wants to harm it's domestic industries by raising its costs above that of its rivals.

But the great thing about $100 oil is that it is a market-imposed price, and it affects all players equally. This results in two very good things. First, America gets more efficient with its energy use. This is why energy per dollar of GDP has dropped rather dramatically in the late 70's/80's. (This obviously has benefits for greenhouse gas emissions as well). The second good thing is that it makes alternative sources of energy far more economically viable. Entrepreneurs are naturally reluctant to enter a market that is artificially sustained by government policies, since such policies are subject to change on short notice. But a market that is defined more organically - as the current one is - and which is not poised to change (as a finite resource with increasing demand, it is hard to see oil prices dropping dramatically for any sustained period of time) will attract entrepreneurs and innovators who see a more sustainable positive environment.

In other words, $100 oil could be the best thing that ever happened to our dependence on foreign oil: it could be the very thing that helps us to kick the habit.

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