Energy Tribune

Lots of people favor free markets. But few are more vociferous about the need for free markets in the energy business than the Cato Institute’s Jerry Taylor. How serious is he? Well, Taylor even favors the abolition of the strategic petroleum reserve, which has been one of the centerpieces of American energy policy since the 1973 oil embargo.

In May, along with Peter Van Doren, Taylor wrote a piece in which he said that whenever conversations focus on the oil business, “the human brain spontaneously short-circuits, nodal synapses fire randomly, and I.Q. points bleed out of the cranium and all over the kitchen floor. Taylor, a graduate of the University of Iowa in political science, has been a senior fellow at Cato since 1991. He exchanged emails with Robert Bryce in mid-September.

ET: Why is there so much demagoguery about energy in Washington?

JT: Politicians are in the business of maximizing their stock of political capital, and there’s a lot of political capital to be gained by mucking around in the energy sector. Consumers demand protection from high prices and are suspicious of energy markets. Security-minded voters are in a panic about our dependence on foreign sources of oil. And many producers (like eastern coal operators or ethanol producers) are concentrated and well organized in politically important states and will sell their votes to the highest political bidders. Put that all together, and it’s actually something of a wonder that energy markets are as free as they are.

ET: Put another way, where is there so little willingness to accept the increasing integration of the global energy market?

JT: The case for free trade and global markets is a hard sell under the best of circumstances. Selling the economic virtues of oil imports is nearly impossible.

ET: Should America’s need for imported crude, refined products, natural gas, and other energy commodities be of any concern to policymakers?

JT: No. If the aforementioned energy sources become scarce – or the supply of the same becomes unstable – prices will rise and the appropriate signals to market actors will follow. If and when it makes sense to switch from those energy sources to other energy sources, market actors will make that switch of their own accord. Likewise, if fuel diversification or supply diversification makes sense, then market actors will diversify. If it doesn’t make economic sense, they won’t.

ET: In 2005, you and Peter Van Doren wrote a paper arguing against the need for the Strategic Petroleum Reserve. Given that other countries (like China) are building SPRs, why should the U.S. do without one? And second, doesn’t the SPR offer some protection to the U.S. in the case of a major disruption in crude oil supplies?

JT: The observation that China is building an SPR tells us nothing about the economic merit of the same unless we believe that Chinese policymakers operate in an error-free manner, which of course they don’t.

Nevertheless, imagine a world in which the Chinese have an SPR but the United States does not and there is a supply disruption abroad. China releases oil from its SPR. What happens? Oil prices go down in China and the United States by the same amount. Hence, an SPR provides no strategic or comparative advantage to nation states.

The SPR is not large enough to help the economy much in the face of a major supply disruption like, say, the loss of Saudi oil. It is only large enough to help the economy in the face of relatively small and temporary supply disruptions. Regardless, there is no hard evidence to suggest that market actors systematically under-invest in oil inventories. Hence, there is no market failure and thus no case for government intervention. If there were a market failure, however (for instance, if market actors were found to under-invest in oil inventories out of fear of some future price control or profit extraction regime), the best remedy would be to provide some sort of subsidy – maybe a tax preference – for investment in oil inventories … not an SPR.

ET: In August, you and Van Doren wrote a paper arguing against gasoline taxes. You argued that pollution taxes, congestion pricing and insurance premiums pegged to actual miles driven would be better solutions. Why?

JT: Gasoline taxes are often sold by policy intellectuals as efficiency-enhancing taxes because they internalize the negative externalities associated with driving. But if we want to internalize those externalities with a Pigouvian tax, we should tax the externalities directly. Hence, if we want to reduce the pollution associated with driving, we should tax tailpipe emissions directly. If we want to reduce congestion, we should charge to use roads during busy periods. If we want to reduce the number of accidents associated with driving, we should tax vehicle miles traveled.

A gasoline tax is a very inefficient way of tackling the externalities related to driving. For instance, fuel taxes in England are extremely high, but London has long been one of the most congested cities in Europe. But once user fees were applied to cars entering the center of the city, congestion problems eased dramatically.

ET: You’ve written several pieces about the ethanol scam. And yet the scam flourishes. Given the growing subsidies for ethanol and the Senate bill that would mandate 36 billion gallons of ethanol production by 2022, can the ethanol juggernaut be stopped? If so, how?

JT: I am a policy analyst, not a political handicapper. My job is to make the best policy arguments I can and then let the chips fall where they may. I leave the politics to someone else.

If consumers come to believe that price hikes in the grocery store can be attributed to the ethanol program, that gasoline prices are also higher as a consequence, and that corn ethanol is environmentally undesirable despite what they’ve heard, then I suspect that public support for ethanol consumption mandates will decline quite a bit. Whether criticisms of the federal ethanol program will penetrate the public conscious, however, is anybody’s guess.

ET: Amory Lovins has become a darling of the left and the Greens. And they love him even though he has been consistently wrong about the adoption of alternative energy, renewables, and cellulosic ethanol. Why is he so popular? And what’s your take on his promotion of ideas like the “hyper car, “negawatts” and “negabarrels”?

JT: Negawatts might make sense when utilities are living under a regulatory regime that dictates weighted average cost pricing. If marginal production costs in those regimes are higher than the weighted average production cost of all sources of electricity, then utilities may well find it economically attractive to pay consumers not to consume; especially if state regulators guarantee a healthy rate of return for those expenditures.

When Amory Lovins first floated the idea of “negawatts,” that was arguably the case in many service territories. But it’s not so clearly the case today. Regardless, negawatts are still a second-best alternative to the first-best reform, which would be to eliminate weighted average cost pricing and to institute real-time pricing of electricity.

Even so, empirical investigations of utility-sponsored demand-side management programs find that they typically save very little electricity at prices many times higher than electricity production costs. So no matter how attractive one might find the theory in concept, it has been extremely hard to execute in any cost-effective manner in practice.

I don’t know what a “negabarrel” is supposed to represent, so it’s hard for me to say anything worthwhile on that score save for the fact that there is no good evidence to suggest that consumers are passing up profitable investments in automobile fuel efficiency. In fact, the literature suggests that consumers often over-value fuel efficiency when they are assessing the trade-offs between lower-cost fuel inefficient vehicles and higher-cost fuel efficient vehicles that are otherwise similar.

ET: I’m an admirer of Vaclav Smil’s many books about energy. Among the many people who write about energy and energy policy, who do you like?

JT: I like Vaclav Smil too. I also think quite highly of Richard Gordon (Prof. Emeritus, Pennsylvania State University), M.A. Adelman (Prof. Emeritus, MIT), Timothy Considine and Andrew Kleit (both at Pennsylvania State University), Franz Wirl (University of Magdeburg), Paul Joskow (MIT), Gilbert Metcalf (Tufts), Robert Michaels (University of California, Fullerton) and energy consultant Michael Lynch.

ET: What books about the energy business are your favorites? What about periodicals?

JT: Peter Van Doren’s Politics, Markets, and Congressional Policy Choices (U. of Michigan, 1991) is a tremendous overview of the history of federal energy policy and the political considerations that have dictated the course of the same. For the long version of that story, see Rob Bradley’s magisterial Oil, Gas, and Government (Rowman & Littlefield, 1996). M.A. Adelman’s The Genie out of the Bottle: World Oil Since 1970 (MIT, 1996) is a great overview of how modern international oil markets work with a particular eye towards the impact that OPEC has had on them. Vaclav Smil’s Energy at the Crossroads (MIT, 2004) is a very good primer on all aspects of energy and energy markets. Franz Wirl’s The Economics of Conservation Programs (Kluwer, 1997) is a tremendous review of, well, the economics of energy conservation programs. Douglas Bohi’s and Michael Toman’s The Economics of Energy Security (Kluwer, 1996) is a very crisp and competent demolition of the idea that the desire for energy security per se justifies government intervention in energy markets.

The only specialized journal I read regularly is The Energy Journal, which is published by the International Association for Energy Economics. It’s invaluable. But to keep up with the energy literature, you’ve got to keep an eye on all of the economic journals – which we do.

ET: If the president put you in charge of U.S. energy policy and gave you carte blanche, what would you do?

JT: I would get the federal government out of the energy business entirely. No DOE. No energy R&D. No FERC. No NRC. Authority to regulate the electric utility sector should be left to the states. I would then privatize most of the federal lands and let energy interests compete with other interests in the market for ownership of the energy rich lands currently in the federal estate.

This explains, by the way, why none of the presidential candidates are likely to put me in charge of U.S. energy policy any time soon. But that’s fine. Cato’s job is to change the political terrain in ways favorable to liberty, not to accept the political terrain as a given and operate on it as best we can. We think that the progress in the war of ideas will allow us to (slowly) change that political terrain. If we have some success in that regard, it can’t help but move public policy in a positive direction – even if it were never to arrive at our favored destination.