Tuesday, October 17, 2006

High Prices Will Reduce Dependence on Foreign Oil

Today's Wall Street Journal has an interesting article about what lower gasoline prices are doing to the alternative-fuels industry. Although gasoline is still on the expensive side, there is concern that interest in ethanol, hybrid vehicles, and other fuels and technologies may quickly wane if gasoline prices go much lower.

I've written about this vicious cycle before. When gasoline prices spike, we see a marginal reduction in demand. That results in higher inventories, which cause prices to come back down. When prices fall, drivers fill up their SUVs and hit the road again.

President Bush is very concerned about this. He says America is addicted to oil and considers our dependence on foreign energy a serious national security and economic threat. He has made it a priority to push alternative fuels and technologies. Although he's happy to see gasoline prices go lower, he is worried that lower prices may kill the enthusiasm for alternatives.

Ironically, Bush and the Republicans have also been accused of somehow causing gasoline prices to fall in order to improve their chances in the upcoming mid-term elections. This is baloney. Oil and gasoline are commodities whose prices are set in open markets by buyers and sellers. Other than ordering the release of oil from the Strategic Petroleum Reserve, the president cannot affect prices in the short term.

As I've written before in the Forbes Growth Investor, I am opposed to price caps on gasoline. Capping the price will result in shortages. However, I am in favor of a price floor.

Price is the best way to affect behavior. If you want people to use more of something, make it cheaper. If you want them to use less, make it more expensive. By setting a floor on gasoline prices, we can get consumption under control. Gasoline would not be wasted and there would be a real incentive to move toward alternatives.

The government would collect the difference between the floor price and what the market price would have been without a floor. Don't get me wrong. I am not in favor of giving the government more of our money. Those revenues should be used to fund research into alternatives, and to reduce other taxes.

Of course none of this is likely to happen. Setting a floor requires the kind of political fortitude that many elected officials lack.