And this is why free markets are not as efficient as you all think.
The Real Question: Should Oil Be Cheap?
Expensive oil hurts, but there's a business case to be made for a floor under the price of crude
by John Carey
This Issue
August 4, 2008
Amite Foundry & Machine is one of those gritty manufacturers at the heart of American industrial might. The Louisiana company's fiery 2,800F furnaces melt down hunks of recycled scrap steel and recast them into massive parts for trucks, oil rigs, and other heavy equipment. Amite even turned 30 tons of metal from the World Trade Center into the bow of the Navy's USS New York. But the company suffered as manufacturing moved offshore, and the town of Amite, 65 miles north of New Orleans, with its faded white clapboard churches and a main street that time forgot, has suffered along with it.
No more. Amite Foundry's orders jumped 25% in 2007 and 30% more so far this year, spurring the company to hire dozens of workers. Why the turnaround? The price of oil. With the cost of a barrel of crude well north of $120, anything that can provide additional supplies, alternatives, or gains in energy efficiency is booming. One example: Canada's oil sands. They're boosting sales of Caterpillar's (CAT) 380-ton-capacity mining trucks—and Caterpillar uses nearly 50 tons of Amite's steel castings per vehicle. Sure, increased energy and commodity costs make it more expensive to produce and ship steel, says Roy Roux, sales chief at parent Ameri-Cast Technologies, but "high oil prices are mostly good for us."
Paying for the Past
Obviously, the soaring cost of energy is causing plenty of pain for Americans, especially at a time when they're being hammered by declining house values and rising food prices. The pain isn't about to ease, either. "We haven't yet seen the cost of heating," warns R. Neal Elliott of the American Council for an Energy-Efficient Economy. That will kick in this fall and winter, with dramatic increases in the prices of heating oil, natural gas, and even electricity.
But Amite Foundry's resurgence is just one of countless examples of a deeper truth: Expensive energy, in many ways, is good. Why? When the price of oil goes up, people will use less, find substitutes, and develop new supplies. Those effects are just basic economics. Things are so painful now, many economists say, because of the past two decades of cheap oil. Prices stayed low in part because they didn't reflect the full cost of extras such as pollution, so there was little incentive to use energy more wisely. If those extras had been counted, the country would be better prepared for both today's soaring prices and the day that global oil production begins to decline.
That's why there is growing interest, from both the left and right, in a policy that uses taxes to put a floor under the price of oil. Above a certain level—say $90—there would be no tax. But if the world market price dropped below that, taxes would kick in to make U.S. users pay the target amount.
Expensive energy is a powerful medicine. It may hurt when taken, but it brings long-term cures for a host of ills. It compels companies and people to put fewer miles on the car, ditch the SUV, or install more efficient heating, as Eastern Maine Medical Center in Bangor did: The hospital saves $1 million annually with a system it installed two years ago. Higher costs are beginning to nudge America away from its traditional traffic-congested suburban sprawl to denser, less car-dependent communities. Utah has a government-sponsored bike-to-work program. "When the Republican governor of the reddest state in the union is promoting bicycling as a preferred mode of transportation, you know people are paying attention to the price signals," says Keith Bartholomew, professor of urban planning at the University of Utah.
These changes are saving lives—fewer traffic deaths—and improving health as people get out of their cars. A study from Washington University in St. Louis suggests that 8% of the rise in obesity since the 1980s was due to low gas prices, which led to less walking and biking and more restaurant meals. Silicon Valley engineer Andy King parked his Chevy Suburban in favor of a bike for commuting and says he has dropped 35 pounds since February. "It's good for my body and soul," King says.
High energy prices also water the flowers of innovation, making investments in alternatives pay off and juicing the search for more oil. Military-funded researchers have made jet fuel from plants. Toyota (TM) and General Motors (GM) are testing plug-in hybrid cars that can run 40 miles on electricity alone. Companies are building vast expanses of mirrors in the desert to make steam, and thus electricity, from the sun. There are new systems to control power consumption by homes and businesses from afar and programs to insulate inner-city houses, providing energy savings—and jobs. The U.S. uses just over 20 million barrels of oil per day heating homes, powering industry, and fueling cars, trucks, and planes. Energy-saving initiatives, "could easily take 4 million to 5 million barrels a day of demand off the market in 10 years," says Stanford professor Hillard G. Huntington, executive director of the Energy Modeling Forum, a group of energy experts.
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