I just returned from my ten year business school reunion. While I expected to have a good time catching up with old friends, I was pleasantly surprised with the outstanding content of event. My favorite session was by Professor Forest Reinhardt on Energy in the New Century.
As was frequently the case when I was a student, the most interesting part of the session was the discussion after Professor Reinhardt’s presentation rather than the presentation itself (which was great, too). Someone asked the good professor why he had spent so little time discussing alternative energy [to fossil fuels]. His answer was that there are two big consumption categories for energy — “automobiles” and “everything else.” Alternative energies are substitutes for fossil fuels in the “everything else” category. But there aren’t good substitutes for oil when it comes to automobiles. The lack of good auto fuel substitutes gives oil an energy monopoly for a significant segment of the overall energy market. Several years ago, Jeff Cordova made the same argument to me over lunch.
Why high oil prices are good thing.
You can match supply and demand by (1) increasing supply or by (2) decreasing demand.
The problem, in energy, is that increasing supply can take a long, long time. Building electric power plants takes time. Despite nuclear power’s clear advantages in efficiency and environmental impact, there has been limited appetite for new nuclear power plants since Three Mile Island. And only a sustained long-term increase in the price of oil will provide sufficient incentives to producers to extract high cost fuels required to increase oil supply. Think about it from the perspective of oil produces — what if oil prices collapse? The Saudis claim that they have huge resources ready to bring online (clearly a healthy bit of game theory to discourage further increases in competitive supply). Many people doubt that this is true, but only the Saudis know what they have ready to tap (and they may not even know). No matter how you look at it, increasing supply takes time.
On the demand side, asking people to be good citizens ignores basic facts about human behavior. And energy efficiency just makes it easier (from a cost perspective) to consume more energy — so overall demand doesn’t decrease in the medium to long term. The single best way to manage consumer demand is by increasing prices. One way to improve energy efficiency would be to put systems in every business and every home that clearly shows users the cost of their consumption. Vary pricing throughout the day to encourage consumption at off-peak periods. Since our power plants run most efficiently when they are at full capacity, and since they are so rarely at full capacity, it turns out that doing this would dramatically increase the capacity of our existing infrastructure and would be cheaper than any other alternative. It could also happen relatively fast. Another alternative to alternative energy for the “everything else” category is to figure out a better way to store energy. On the automobile side, price increases at the pump happen frequently and immediately decrease demand.
Higher oil prices will increase oil supply (eventually), encourage the development of substitutes, and decrease demand. For the long-term health of the environment and the global economy, there is probably nothing better than very high oil prices.
Houston, we have a problem.
Sustained high-oil prices will lead to the development of numerous substitutes for “everything else.” There will not be an energy problem AT businesses, factories, and homes. We will manage to find CHEAP and CLEAN options for “everything else.” But what about automobile power consumption? Unless someone figures out how to deliver these oil substitutes in liquid form, we still have a big energy problem. And the only current solution to the problem is to decrease demand through high prices.
The technical innovation most likely to change the world for the better is dramatically better battery technology. Not solar, not biofuels, and not wind — storage is the high probability bet. By tapping into the rich (and growing) sources of substitute energy options for “everything else,” we can end oil’s energy monopoly. Every single dollar of government investment going to alternative energy sources should instead be invested in basic research to improve battery technology. Brilliant scientists eager to start companies should consider focusing their energies on building better battery technology rather than working on yet another energy substitute for “everything else.”
This is not to say that research and development of alternative energy options like solar and biofuels isn’t a great thing — it is a great thing. But adding more substitutes for the “everything else” bucket is not the biggest bang for our collective buck. The change-the-world opportunity here is to bring the entire range of existing and emerging oil substitutes to the automobile. And to do that, we need better battery technology.
14 responses so far ↓
Sam Pullara // June 1, 2008 at 7:49 pm |
This is true even outside portable power. For things like solar power to work well you need a very efficient place to store all the energy captured during the day.
Sean // June 2, 2008 at 2:56 am |
If you haven’t done so yet, read Thomas Friedman’s recent op-ed on this very same topic: (http://www.nytimes.com/2008/05/28/opinion/28friedman.html).
At a high level he agrees with you. Keep gas prices high to drive demand down, and in doing so, kick off a virtuous cycle that will even further decrease demand. He argues that drivers will decrease their demand not only by driving less, but by choosing more fuel efficient cars. Demand for more fuel efficient cars encourages the car manufacturers to focus more time, energy, and money on developing more fuel efficient cars. A greater supply of fuel efficient cars drives the demand for gas even further down.
And while you are at it, also read Steven Levitt’s piece on the same topic: http://freakonomics.blogs.nytimes.com/2007/06/18/hurray-for-high-gas-prices/
His conclusions are quite interesting. He calculates that fighting global warming (through fewer carbon emissions) is not the primary benefit to society of higher gas prices. He argues that higher gas prices benefits society more through (a) decreased congestion (i.e., you waste fuel when driving in a traffic jam) and (b) fewer accidents (resulting in lower insurance premiums).
Bottom line, high gas prices are good!
Elia Freedman // June 2, 2008 at 4:58 pm |
What also needs to be recognized in this equation — but is never talked about — is that supply will go up for automobiles as we stop using oil for everything else. This should serve to stabilize prices to a certain extent. Of course, there will be upward pressure on pricing again as more Chinese drive cars and as we hit peak production, but those are other issues altogether.
Paul Hunt // June 2, 2008 at 6:15 pm |
Elia, I don’t know if that equation can work. Oil is used in many diverse ways which are all integrated into our lives. I’m not saying you’re wrong I just don’t understand completely what you’re saying. Besides cars, oil is used to make plastics that we use every day. I was reading this articled called The U.S. Oil Supply – A Look at Our Future Needs and it talks about how oil is drying up. Its not a renewable resource and eventually will run out. So this makes me think, besides for environmental concerns, that green energy is the way to go.
xgreen // June 2, 2008 at 9:29 pm |
There are more alternatives to oil for transport than just better battery technologies.
Increased investment in public transit, improvements in rail infrastructure, compressed air vehicles, hydraulic hybrid technology, biodiesel derived from algae, and more livable cities are all going to provide a lot of help with this problem.
Our measure of standard of living needs to account for more than just buying power and basic rights. A healthy lifestyle, live work environments, locally grown foods, the ability to walk or bike to get where you WANT to go, and less consumption are all worth more consideration.
Bill O // June 2, 2008 at 11:44 pm |
While the increase in price of oil (or anything) directly and almost immediately impacts demand, at what point have you reached or passed the point at which the benefit is worth it?
If oil were $1,000,000 per barrel tomorrow, clearly this would be a bad thing as the global economy would halt. The perfect price point would be one at which people really feel pain at the pump enough to make them alter behavior, but where they still have money to spend. Have we reached that point yet? Doubtful, since every other car on the road is a Suburban…but consumer behavior takes time to change. Especially when the alternatives don’t exist yet. Mrs. Soccer-Mom can’t use a Prius because you can’t fit three car seats in it.
Maybe the people/entities that are in the best position to effect a change should pay more for gas? Or maybe there should be a big penalty to those companies that pollute too much, and that pays for an X-prize(s) award to an innovator? We need a pro-active combination of carrot and stick to make the changes happen faster.
Found a Great New Blog, Great Essay on Energy // June 3, 2008 at 2:31 am |
[...] an essay explaining why battery innovation is one of the most important fields of scientific researc… for the US Speiser says: The single best way to manage consumer demand is by increasing prices. One [...]
Chris Keane // June 3, 2008 at 11:49 am |
Like most arguments for free markets, arguing for higher oil prices is comfortable for affluent audiences but it overlooks the experience at the lower end of the economic ladder.
People are already feeling the pain of high oil prices, you (and the economic decision makers) are simply overlooking them. Check out Below the Line, Tavis Smiley’s radio series on poverty, where people describe the experience today of trying to find work when they cannot afford gasoline for their car. Alternative transportation isn’t viable in most American cities is terrible, so people get trapped in a cycle of poverty.
Expensive gasoline may simply be a financial decision between buying an SUV or a Prius for some people, but for many (disenfranchised) people this decision has a real impact on their health and livelihood.
Xgreen’s comment proposes more humane solutions that should precede any “price it out of the market” strategies: make cities livable for people who cannot afford expensive oil. Deferring responsibility to the mechanics of supply and demand is popular with people who can make the strongest demands, but it is inhumane in an uneven economy.
Mike Speiser // June 4, 2008 at 5:23 am |
Chris,
I certainly didn’t mean to imply that I like high oil prices. That’s an absurd position that I certainly do not hold. If that’s how it came across, my apologies. My goals are to lower the environmental impact to the planet and lower long-term energy costs.
I suggested two things that will help us accomplish these goals:
1. High oil prices will lead to alternatives that will lower environmental impact and will eventually lower prices of energy for everyone. And high prices will hold back demand. These are good by-products of the terrible situation we find ourselves in today.
2. Alternative energy won’t solve the energy problem for autos, as it doesn’t transfer to portable energy consumption (autos). Thus, better battery technology would bring alternatives to a huge segment of the market.
There are only two ways of lowering prices — increasing supply or decreasing demand. Substitutes for oil will increase supply for “everything else”, but won’t impact “autos” until we figure out how to liquify oil alternatives or until we figure out much better energy storage solutions. And high oil prices will help fuel developments in alternative energy and battery technology. The other solution is to decrease demand, and high prices do that quickly.
Xgreen did offer a third option that I hadn’t suggested. If everyone moved to highly urban areas, public transit powered by electricity would work. To do that we would either need to force a massive number of people to move (wouldn’t work in a democracy, but could work elsewhere in the world) or we could provide massive incentives for people to move (no taxes for people who live in urban areas might work).
-Mike
Chris // June 5, 2008 at 3:25 pm |
Hey Mike,
Thanks for clarifying. I think that your point #1, that high oil prices will eventually cause enough pain to incite change, is already underway. The problem is that the first stage of that change is that poor populations aren’t able to incite change. Their “alternative” is joblessness, welfare, etc. I don’t think that’s an acceptable price to pay, so we can’t wait for market pressures to force a change.
Per Xgreen’s suggestions, even if migrating to urban centers were to happen, the poor (who need alternatives most) would likely lead that migration, which in turn would make urban centers less appealing to the wealthy. If the rich live in the country and the poor live in the city then I don’t think we can realistically expect urban areas to become more appealing. I’m not a historian, but it sounds like convincing people to move to urban areas would be an attempt to reverse the suburban diaspora that has defined the 20th century United States.
I think your description is an accurate prediction of my future experiences and yours – when gas prices get high enough we’ll trade our SUVs for Chevy Volts (and car manufacturers who have solved the battery problem will win), but I don’t know what the solution is for the populace with more constrained choices. Cheap electric cars?
Your blog is an excellent read. I’d love to see you do a week (month) of posts dedicated to entrepreneurial ideas with a social bent – make it profitable to be good.
Thanks
Chris
Mike Speiser // June 5, 2008 at 4:06 pm |
Excellent feedback Chris. And I will start working on your challenge — it’s always good to have an objective when thinking about ideas and I think ideas with a social bent is a good one to have. Thanks again, love that you are part of the discussion.
neal sample // June 6, 2008 at 12:09 am |
Okay, I’ll bite. If *storage* is the primary problem, then why isn’t hydrogen the answer for automobiles? It’s a high-energy, portable solution that can be used in automobiles, even if it’s far less than ideal for “everything else.” Transmission loss of hydrogen (in transport via tanker) is far less than electrical transmission over all but the shortest distances. And hydrogen doesn’t leak the same way capacitors do. And the storage model is trivial: thick-walled tanks.
I must have been misled by the blog title. ;_
Mike Speiser // June 7, 2008 at 2:36 am |
Isn’t hydrogen highly volatile (as in spectacular explosion on collision volatile)? And doesn’t it take a good deal of energy to turn water into hydrogen fuel? What would the net fossil fuel energy savings be in this case? Or are you trying to build a space shuttle?
Marc Milgrom // June 9, 2008 at 9:59 pm |
Hydrogen does take energy to extract from water, but the next generation concept will be to run combined solar power generation and hydrolysis to produce hydrogen.
Hydrogen gas is volatile, but it can be stabilized for use in fuel cells by metal surface deposition for example… which brings the discussion back to improved storage.