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Gifts for all occasions in the Galleria! The "What is the Deal?" Deal-of-the-Week: Please donate to the Salvation Army for hurricane relief. October 2, 2005 The Economics of Gas By Jan A. Larson Americans are naturally upset and nervous about the price of gasoline. Soon, they will be equally upset and nervous about heating oil and natural gas. While I don't wish gasoline price-induced hardship on anyone, this is the best thing that could happen to transform America's dependence on oil in general and foreign oil in particular. The hand-wringing over oil prices and the "solutions" offered by politicians such as increasing taxes on inefficient vehicles, offering tax incentives to buyers of hybrid cars and, worse of all, capping gasoline prices (as the state of Hawaii did on wholesale gasoline) all are counter-productive in the long run. Despite a recent announcement from the Saudi oil minister and the president of Exxon Mobil that said that the world petroleum reserves will "last for decades," the fact remains that there is a finite supply of oil and decades have a habit of going by. That supply is, in fact, a lot larger than many believe, but measures that keep prices low and supplies plentiful only serve to hasten the arrival of the inevitable day when oil supplies are tapped out. Since the 1981 spike in gasoline prices (the equivalent of over $3.00 per gallon in 2005 dollars), gas has been a bargain. As a result, Americans have not been overly concerned about gas prices or automobile mileage because it didn't cause much pain to fill 'er up. Now a lot of Americans are looking for ways to cut their gasoline costs. In some cases, that means putting the gas-guzzler in the garage. In other case, it means reducing or combining trips, sharing rides or taking public transportation. Some are even trading in their SUVs for more fuel-efficient vehicles. While conservation and switching to more fuel-efficient vehicles are helpful in the short-run, the immutable laws of economics dictate that lower prices at the pump or better mileage on the road don't translate into oil conservation. If it is cheap to drive, people drive more. The result is that our dependence on foreign oil continues unabated despite years of Washington rhetoric calling for its end. Only when prices increase to painful levels do drivers start looking for alternatives to reduce the cost per mile, such as riding sharing, improving mileage, parking the gas hog, etc. It is this effort to seek more economical ways to get from point A to point B that opens up opportunities for alternative energy sources. As long as oil is cheap, there is no economic incentive to look for anything else. When the price of oil goes up, then alternatives become relatively more attractive. As far as alternatives are concerned, there has been a lot of talk in the media about hydrogen as a viable alternative to oil. Hydrogen fuel cells sound promising, producing only water as a byproduct. The problem with hydrogen is that it takes a lot of energy to separate hydrogen from the oxygen in water or the carbon in methane (natural gas). In addition, the production of hydrogen from methane produces carbon dioxide. Hydrogen would be much more viable if we had oceans of hydrogen instead of oceans of water. Ethanol has also been touted as an alternative. Ethanol, produced from corn or sugar cane, also requires a significant amount of energy to produce - the energy to plant, water and harvest the corn or cane, plus shipping and processing. Neither hydrogen nor ethanol promise to provide viable energy alternatives in the near-term, however there are proven technologies that can provide short-term relief. One of these technologies is ... oil. That is domestically produced oil. Environmental restrictions have stifled domestic exploration off the coasts and in the Alaska National Wildlife Refuge (ANWR). We are going to have no choice but to increase domestic production as well as refining capacity as the pain at the pump continues. The second technology that must again be brought to the forefront is nuclear power, although bringing new nuclear plants on-line is not a short-term proposition. The first image that comes to the minds of many when they think of nuclear power plants is that of a mushroom cloud, which is totally ridiculous or Chernobyl, a disaster resulting from a fundamentally flawed and dangerous design. The fact remains that nuclear energy is the cleanest and most efficient source of large amounts of energy. Since gasoline is an essential commodity and is controlled by an oligopoly in an industry with large barriers to entry, there is little anyone can do about gas prices in the short-term other than take measures already mentioned. With China and India poised to increase their petroleum usage in the coming years, it is imperative that the United States moves to other sources of energy and today's high prices may finally provide the economic incentive to do so. As long as there is no economic incentive for consumers to change behaviors or for the development of alternative energy sources, neither will happen. Fortunately, we may now be reaching the point where the economics will dictate change. -- Send feedback to the author. The "What is the Deal?" column will appears weekly on the Pie of Knowledge website. Guest submissions are welcome and encouraged. To submit an article to "What is the Deal?" click here. To subscribe to the "What is the Deal?" mailing list and receive early notification when a new column is available, click here. The Pie of Knowledge will never, ever divulge email addresses to any third party for any reason unless so ordered by a court of law. 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