Environmentalists and energy prices 2.0

One thing I can’t make head nor tail of is how people who are concerned about the environmental impacts of fossil fuel consumption also seek to combat high or volatile oil and gas prices. I got on this idea today after reading a post by Brad Johnson (@climatebrad) originally at his site, The Wonk Room, and later cross-posted to Grist.org. I share a lot of the same concerns as Brad with respect to the environmental impacts of fossil fuel consumption. As a result, I think it’s reasonable to ask whether supply-side effects of high oil prices are good or bad news for the environment.  On the consumption side though, either higher or more volatile oil prices will decrease consumption of oil products over the long term, which I can’t see having an environmental down side. All else equal, make prices less volatile with the same underlying trend or reduce oil prices and consumption will go up. I doubt you can find an economist anywhere who will argue with this.

The premise of Brad’s post, and the results of the report cited in it, are absolutely correct – volatile gas prices are harmful to both the macro-economy and to gas consumers.  Price swings hurt because energy consumption occurs through mostly durable goods – cars, houses, etc. – and so it is costly to quickly change consumption patterns in response to price swings, and also costly not to change. To use Brad’s term, consumers are locked-in.  However, it’s this possibility of getting locked in to a high-cost home or car which implies that volatility, all else equal, will decrease energy consumption, not increase it, over the long term.

The preponderance of economic evidence suggests that consumers are risk averse. In fact, 2002 Nobel Laureate Dan Kahneman suggested that our risk aversion might be the reason we survived as a species. Risk aversion implies that energy price volatility will lead consumers to reduce their dependence on energy and increase their access to alternatives.  For example, if you want to reduce the impact of gas price volatility, having the option to bike, walk, or take the bus to work is a great insurance policy. In fact, most of the ways in which consumers can insure themselves against oil price volatility are activities which have significant environmental upside.  If you know with certainty what gas prices will be, there is no need to buy insurance by paying more to live closer to the downtown core or on a rapid transit route unless you plan to use those options as a regular means of transit – there’s no insurance value.

People tend to pay a lot of attention to gas prices when they go up, and the news is full of people complaining about filling up their SUVs on the way in from the suburbs.  It’s reasonable to assume that if, instead of being volatile, gas prices were steadily at the levels seen today, many of those people would sell their SUVs and/or move closer to their places of work. If you want lower emissions, you see this as a missed opportunity – if only we hadn’t had that 2008 crash, perhaps these people would be driving hybrids.  That’s not a volatility story, that’s just wishing oil prices were higher, or wishing there were a carbon price.

If you want to see the effects of volatility, you also have to look on the other side of the ledger – what about the people who bought high efficiency furnaces when natural gas prices were in the double digits? What about the people who bought a shiny new hybrid right before the crash because they believed Jeff Rubin that oil was going directly to $200/bbl?  They are not seeing anywhere near the return on their money they would have expected.  These people just don’t happen to be featured on the 11 o’clock news, and environmentalists aren’t complaining that energy markets should be regulated because people bought too many hybrids or high efficiency furnaces before the crash.

I’m all for efficient oil markets and clear price signals, but if you start trying to remove risk from energy prices, you should not be surprised when consumption goes up.  Before you argue for reducing energy price volatility, ask yourself if you are wishing for that.

3 responses to “Environmentalists and energy prices 2.0”

  1. Dan Wolfe

    I completely agree. It’s the shock of a sudden change that makes people take notice and change their behaviour. A more gradual rise in the price of energy will only lead to more boiled frogs, so I see the volatility as a good thing.

  2. Shi-Ling Hsu

    Two thoughts: (1) an historical overlap of environmentalists and old-fashioned liberals like the NDP (hence Jack Layton’s call for a cap-and-trade that would miraculously avoid price increases), and (2) the *identifiability* of people that would be harmed by higher energy prices. We tend to construct a sympathetic story about people that lose mobility or turn down the thermostats in their home, and it sticks more than any story about environmental benefits. We also self-servingly like to blame other people for environmental ills, a delusion that is more ironic in the climate change context.

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