Since the 1970s, North American and European governments as well as many policy analysts have believed that fossil fuels will gradually be replaced by "softer" sources of energy--mainly renewable energy sources such as windpower, solar power, biomass, geothermal power, speculative hydrogen power technologies and energy conservation. These soft energy sources have been considered more environmentally benign than coal or oil and nearly as attractive economically Soft energy advocates believe that only a moderate amount of government intervention is necessary to increase the use of soft technologies and the efficiency of the economy.
The state and federal campaigns against fossil fuels, however, have not produced the quick victory that advocates predicted. Instead, they have taken on the characteristics of the Vietnam War. For over 25 years now, between $30 and $40 billion has been spent to force soft energy onto consumers(1) in a campaign employing a dizzying array of federal and state taxes, subsidies, preferences and consumption orders.(2)
Indeed, victory over fossil fuels is nowhere in sight. Renewable energy--wind, solar, geothermal and biomass--comprise only 1.5 percent of the energy market,(3) and revolutionary advances in natural gas technology, not soft energy, are fundamentally reshaping the energy industry. Still, soft energy advocates continue to proclaim that an energy revolution is upon us and that just a few more subsidies and mandates are necessary to bring us into the progressive energy promised land.
Soft energy advocates including Amory Lovins and Christopher Flavin justify their call for governmental intervention in energy markets by relying on four arguments. First, they argue that energy markets are riddled with "market failures" that lead to economic inefficiencies. Second, government is said to have subsidized fossil fuels, artificially tilting the market against soft energy Third, such advocates predict that global warming will inevitably force governments to dramatically restrict the use of fossil fuels, making the advent of a soft energy economy a question not of "if" but "when." Finally, soft energy policy experts assume, if implicitly, that they have superior information and insights that market actors simply lack or choose to ignore. Government intervention, they conclude, is the only way to achieve the "best" use of energy
This paper briefly examines the economic and environmental rationales behind the ongoing campaign to promote soft energy Those rationales, while superficially attractive, do not hold up well to scrutiny. There is no compelling reason to believe that soft energy will play any larger role in the 21st century than it does today.
HOW BROKEN ARE THE ENERGY MARKETS?
Remarkably few non-economists understand the exact meaning of the terms "market failure" or "efficiency," despite their promiscuous use in public debate. Harvard University professor Steven Kelman, for instance, interviewed staff members of U.S. congressional committees to determine their understanding of the terms and found that neither Republicans nor Democrats understood either concept.(4) Consequently, the charge of market failure is used with little care or precision and is subject to extensive misuse. Nowhere is that more true than in the energy debate.
Market failures result when the marketplace is unable to secure adequately "public goods," defined as those commodities for which it is difficult to restrict the benefits of trade to those who participate in the transaction. A common example is air pollution. If someone brought suit against a factory's pollution or negotiated a contract with the factory to reduce pollution, the benefits of the suit or contract could not be restricted to the person who filed the charges. The others in the neighborhood, the free riders, would also benefit.(5)
Implicit in the charge of energy market failure, then, is the idea that fossil-fuel markets are characterized by property rights that do not require users to pay for all the costs imposed by their use, and that harmed third parties face public-good problems in organizing a solution. For market-failure arguments to justify government promotion of soft energy, research would have to demonstrate that those "failures" result in fossil fuel prices that are too low and soft energy prices that are too high relative to their "optimal" prices. But as we shall see, research suggests that governmental actions have, by and large, kept petroleum prices above rather than below an unregulated market price.
Unfortunately, most policy activists use the phrase "market failure" as a catch-phrase to identify any sub-optimal economic decisions by consumers (at least, "sub-optimal" as defined by activists). While economists generally believe that free markets are the most efficient means of producing and distributing goods and services--save for when the aforementioned public goods dilemma confronts consumers--the activist definition fundamentally challenges that very premise. While the idea that government planners can generally produce "better" social and economic outcomes than market actors is outside the scope of this paper, suffice it to say that even economists with great faith in government intervention accept that, as long as public goods issues do not arise, markets have proven superior to governmental planning. Indeed, as we will argue, government intervention in the energy economy has proven so dismal a failure that no exception to this rule can be found in our current discussion.
This paper will critically examine four alleged characteristics of energy markets, which give rise to most of the activists' charges of energy market failure:(6)
Petroleum is a nonrenewable resource and thus the preferences of future generations are not being properly considered in the decisions of current owners to deplete petroleum stocks.
The responsiveness of supply and demand to changes in price is very inelastic in the short run. Thus, small changes in either produce large price changes that damage the economy and thus justify intervention to reduce reliance on foreign oil.
Consumers do not find the price of the substantial health and environmental costs of fossil fuel use reflected in energy prices. Thus, pricing signals are distorted, creating inefficiencies in the market.
Energy markets are inefficient because consumers are poorly informed; lack adequate incentives to conserve; react sluggishly, if at all, to changes in the price of energy; have an unjustifiably jaundiced view of soft energy; and are unable to locate the installation, maintenance and repair networks to support soft energy investments.
MUST GOVERNMENT ALLOCATE NON-RENEWABLE RESOURCES?
It is sometimes argued that because petroleum is exhaustible, we need to ration production in ways normal market forces would not in order to ensure that supplies exist for future generations. Another version of this argument, instead of emphasizing future generations' access to energy per se, calls for government planning today to mitigate the negative consequences of inevitable future oil shortages--such as energy price hikes, recessions and political struggle--as production declines due to resource depletion.(7)
If fossil fuels were being depleted at an alarming rate (or even at any consequential rate), the data would reflect such trends, but they do not. Consider the data surrounding proven reserves, which are defined as those reserves that are well developed, "online" and can be profitably exploited under present economic conditions. If present consumption levels were to hold steady, today's proven reserves of oil would last 44 years--a reserve 15 times larger than when record keeping began in 1948. Proven reserves of natural gas would last 70 years, a reserve almost five times larger than that of 30 years ago. Proven reserves of coal would last 221 years.(8)
The U.S. Geological Survey did not attract criticism when it calculated 25 years ago that there are enough fossil fuels to last 520 years given projected rates of demand, and 10 years ago that figure was raised by some analysts to 650 years.(9) Today; one prominent study estimates that 6 trillion barrels of recoverable conventional petroleum exist today (a reserve of approximately 231 years given present consumption), and another 15 trillion of unconventional petroleum is recoverable given favorable economics.(10) Given present rates of consumption, that would give us 231 years of conventional petroleum and 808 years of petroleum resources of all kinds.(11)
Reserve estimates only consider petroleum that "can be recovered under present and expected local economic conditions with existing available technology."(12) If fossil fuels were to become more scarce, prices would reflect that fact and create incentives to increase inventories dramatically.(13) In addition, current reserve estimates presume no further advances in extraction technologies, despite the fact that such innovations have made it possible to increase reserves while maintaining current prices, especially recently.(14) Moreover, the world's stock of fossil fuels is far greater than those of traditional oil, natural gas and coal. For example, as energy economist Robert L. Bradley, Jr. has noted, when technological improvements in the mid-1980s made Venezuela's reserves of orimulsion (a thick energy source consisting of 30 percent water and 70 percent bitumen) commercially viable, the tar-like substance became the "fourth fossil fuel." "Venezuela's reserve equivalent of 1.2 trillion barrels," writes Bradley, "exceeds the world's known reserves of crude oil, and other countries' more modest supplies of natural bitumen add to this total."(15) Tar sands and oil shale also promise similar supplies of fuel if world petroleum prices were to surpass $30 per barrel. All those unconventional fossil fuel alternatives can be refined into today's fuel products...