Tuesday Talks with Dr. Patterson

January 13, 2015

Energy Independence

The talk among market analysts and policymakers last week was the tremendous drop in oil price, which was trading at less than $50 per barrel last Friday.  This is half its price in July.  Of course, a decline in crude oil prices brings a decline in gasoline prices.  I am sure consumers enjoy seeing gasoline prices below $2 per gallon.  This drop in oil price has generated much talk about its implications for the economy, the environment, and for the future of renewable energy markets and renewable energy technologies.  If the current oil price levels are not low enough, some market analysts have even predicted that oil could fall to as low as $30 per barrel during 2015.

 The dramatic drop in world oil price is due to two principal production factors.  First, the United States has expanded production tremendously.  U.S. oil production is now at its highest level in three decades due to new production from shale oil fields using horizontal drilling and hydraulic fracturing technologies.  This production has proven to be a great boon to the state economies of North Dakota and Texas.  Second, the oil cartel OPEC, the Organization of Petroleum Exporting Countries, has maintained high production levels in a deliberate effort to push down world oil prices.  This cartel, formed in 1960 and composed of 12 member states accounting for about 40 percent of world oil production, wants to push world price down to levels that make it unprofitable for U.S. oil producers to operate.  OPEC hopes to see U.S. oil production curtailed in the face of low global prices.

 For the United States and much of the world, low oil prices will on balance have a positive economic impact, as consumers will benefit from the decrease in oil and gasoline prices.  It is expected that consumer savings on gasoline will stimulate other consumer purchases resulting in growth in the economy, despite lower earnings for oil companies.  Already, the stock price of some oil companies has dropped, which will make it more difficult for these firms to raise capital needed to sustain their production activities.  With sustained low prices, gasoline consumption should rise.  This will result in increased greenhouse gas emissions, raising new concerns about climate change.  For several years, consumers have responded to high gasoline prices and lower income levels due to the recession by reducing gasoline consumption.  Auto producers have worked steadily to produce increasingly efficient automobiles in response to consumer demand.  It is premature to assess how automakers will respond if price of gasoline remains low.  However, the market for large (i.e. less fuel efficient) new and used automobiles has already seen increases in price, as consumers move back to these types of automobiles.  Still, automakers also face some constraints on their array of product offerings, as they must still meet certain mandated fuel efficiency standards.   What remains to be seen is the impact the current drop in gasoline prices will have on renewable energy markets and renewable energy technologies. 

When discussing renewable energy, a clear distinction should be made between renewable fuels and other renewable energy (solar and wind energy) used primarily to produce electricity.  Some argue that the market for solar and wind power should withstand the drop in oil prices and should continue to attract new consumers and investors.  The market is adapting to these new technologies and they are proving to be economical and effective.  However, renewable fuels, which are typically blended with gasoline, may face more challenging market and policy factors.  Already, the Environmental Protection Agency has delayed releasing its 2014 and 2015 rulings on the amount of renewable fuels that must be blended with gasoline under the Energy Independence and Security Act of 2007 (See Tuesday Talk from September 16, 2014).  Some policy makers are questioning whether the United States should be pursuing a policy that promotes (mandates) the use of renewable fuels at the current low oil and gasoline prices.  Investor funding for renewable fuel producing firms is also becoming more difficult to obtain.  Finally, and perhaps most worrisome, some policy makers may limit support for public research on the development of renewable fuels or biofuels, curtailing research in this areas at universities and other research institutes.  This is an important policy question that will confront us.

 I would argue that research efforts on renewable fuels should be sustained.  True, the low price of oil currently makes it hard to justify developing these alternative fuels, which currently cost more than the equivalent of $50 per barrel of oil to produce.  However, it is not the current price of oil that matters in making this policy decision; it is the volatility in oil prices that matters.  Oil prices, like all commodity prices, will continue to be subject to great volatility in price due to forces beyond the control of the United States.  This volatility in price will affect production decisions on oil and biofuels in the United States.  In fact, it makes production and investment decisions more difficult, as returns over time will become more uncertain.  So, the United States would remain dependent on the decisions of foreign oil producers.  Furthermore, while global oil supplies seem abundant today, there will come a time when renewable fuel supplies will be needed.  And, the need to reduce greenhouse gas emissions could become even more important, particularly if gasoline consumption grows.  So, there remains a need to seek energy independence and biofuels should be a component of that strategy.

 

Dr. Paul Patterson is Associate Dean for Instruction for the College of Agriculture and Professor of Agricultural Economics.