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By Robert Rapier on Apr 18, 2011 with 26 responses

‘Price Signal’ can be a Weapon for Managing Higher Gas Prices

The Steep Cost of Sudden Price Spikes

One of my recent essays discussed the relationship between high oil prices and recession. Consumers who suddenly find themselves paying more for fuel are hit with the equivalent of a stealth tax, leaving less money available to fuel domestic growth through purchases or investments. Thus, unsurprisingly, there is a strong historical link between escalating oil prices and economic recessions.

But despite the financial pain (in fact, because of it) there is a major upside to higher oil prices. Consumers do respond to the price signal, and this response can provide some protection against further price spikes.

In this essay, I point out how we can mitigate against the effects of sudden price spikes, advocating for a better price signal in conjunction with long-term planning in order to allow consumers to prepare themselves in advance.

Consumers Respond to Rising Gas Prices

As they did during the oil price spike of 2008, consumers are once more demonstrating a response to higher oil prices.

First, they simply cut back on driving:

Drivers start to cut back on gas as prices rise

Across the country, people are pumping less into the tank, reversing what had been a steady increase in demand for fuel. For five weeks in a row, they have bought less gas than they did a year ago.

But that story also illustrates that the response to the price signal is generally not fast enough:

People are still taking a hit, even as they conserve gas. That’s because gas prices are going up faster than people are cutting back. Gas is 32 percent more expensive than it was in April 2010. In all, Americans are paying roughly $340 million more per day to fill up than they did a year ago.

In addition to cutting back on fuel purchases, consumers also start looking at more fuel-efficient vehicles. Demand for hybrid and electric cars is higher than ever, but demand for diesels — long popular in Europe due to favorable taxes on diesel fuel — is gaining steam in the U.S.:

Diesels: Mainstream Competitors to Hybrids?

With gas prices approaching $4 a gallon in many states, drivers are inquiring about fuel-efficient options that go beyond hybrid vehicles and public transportation. More so than in 2008, drivers are ready to get behind the wheel of diesel vehicles, which in some cases are more costly but also offer more miles per gallon. Popular car leasing website LeaseTrader.com says search demand and lease takeovers are up for several diesel models compared with activity from 2008.

Demand for compressed natural gas (CNG) vehicles is also climbing:

Ford Seeing Increased Demand For Natural Gas-Powered Trucks, Vans

With gasoline approaching, and in some areas surpassing $4 a gallon, Ford is reporting high interest in its natural gas-powered vehicles. The company currently offers its E-Series fullsize vans, Super Duty trucks, and Transit Connect compact vans with a Compressed Natural Gas (CNG) option.

Toward a Better Energy Policy

These are all developments that will ultimately slow U.S. demand for petroleum, but economic havoc can ensue while we wait for these developments to evolve. The long-term fatal flaw in U.S. energy policy is that it is based on delivering energy to consumers at the lowest possible cost. This sort of thinking is flawed, and it leaves us ever more vulnerable, and less-prepared as a nation for higher oil prices.

This is the reason I favor a more proactive approach to managing fuel prices. When they rise sharply, consumers are unprepared and they are suddenly hit with unexpected pressure on their budgets. If they knew the price increases were coming, they could better prepare themselves instead of listening to pandering politicians continue to promise a return to happier times of $1 gasoline by engaging in wishful thinking. By implementing the idea of trading higher gas taxes for lower income taxes, 1). Consumers would know the increases are coming and could plan accordingly; and 2). More of the money generated by that price increase would stay within the U.S.

Traditional Political Views on Energy Are Flawed

With oil having risen in price by an order of magnitude over the past decade, I believe the days of ‘cheap’ oil are behind us. Yet instead of responding with proactive long-term planning, we try to cling to the past with silly schemes like tapping the Strategic Petroleum Reserve to ease prices for consumers. Or, we engage in military action to make sure the oil keeps flowing. In response to high prices, our political leaders engage in magical thinking, and they look for scapegoats. One side will claim that oil prices are only high because we haven’t developed our resources to the fullest extent. The other side will claim that they are high because of our failure to invest enough money into alternative energy.

I believe both views are wrong. The first view is wrong because global demand for petroleum is large and growing, and we can’t add enough to the mix to significantly impact global oil prices. That isn’t to advocate leaving our resources untouched, it is simply an observation that developing our resources isn’t going to return us to the days of $2 gasoline.

The second view is flawed because it is simply more expensive to produce renewable energy. This is almost universally true, which is why so much intervention is required to increase the renewable energy share in our energy portfolio. So I don’t believe cheap renewable energy is going to replace expensive fossil fuels. I actually think that expensive renewable energy ultimately replaces much more expensive fossil fuels (albeit at a lower level of consumption than today’s).

At What Price Will Renewables be Competitive?

People often ask me at what price point I believe various renewables will be competitive. I think those price points are farther off than most people think. Consider that in Germany today gasoline sells for $8.35 a gallon. That tells me two things. First, people will continue to drive at much higher prices than we are paying today. They will just continue to make difficult adjustments and that will continue to take its toll on economic growth. But the more important indicator to me is that renewable energy has not ridden to the rescue in Germany at that price point. Electric cars haven’t filled the autobahns, nor have E85 or biodiesel-fueled vehicles. That day may come, but once again the response is slow and those prices take their toll on consumers in the interim.

On the other hand, those high prices have long influenced decisions in Europe around energy consumption. Europeans have opted for more fuel efficient cars, mass transit, and shorter commutes to work, and as a result European per capita consumption is about half that of the U.S. So the price mechanism undoubtedly works. Indeed, it works more effectively than anything else at getting consumers to change behaviors.

Conclusion

While consumers do respond to price hikes on fuel, the response lags, often because of a belief that prices will fall back to historical levels. Pandering politicians don’t help matters by suggesting that prices are high for reasons other than supply and demand. By doing so, many consumers are left with the belief that just as soon as our lawmakers get their hands on those speculators and oil companies fixing prices, or the environmentalists blocking development — they can continue to consume like it was still 1999.

  1. By J.R. Ewing on April 18, 2011 at 10:27 am

    Robert –

    Aren’t such price signals the entire point behind programs like the Low Carbon Fuel Standard? My company sees a tremendous opportunity there for (some) biofuels and natural gas vehicles, the only debate is just how sensitive demand for gasoline is to price (i.e. elasticity of demand) and just how high gasoline prices are going to go in California before they cut the cord on the program.

    I know you’ve spoken on it before, but I think that subject might tie in well to the concepts behind this particular point on fuel prices.

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  2. By Kit P on April 18, 2011 at 11:11 am

    First of
    all, energy is cheap and a relatively small part of economy. Second,
    Americans are rich because we are very productive in part because we
    use energy so efficiently. This is hard to see for those who just
    focus on energy.

     

    Volatility
    of transportation fuel cost and people complaining about is has been
    constant for thirty years. What do we see in the link to ‘Drivers
    start to cut back on gas as prices rise’?

     

    A guy
    wearing a baseball cap filling up a big 4wd pu!

     

    Then what
    do we see in the link to ‘Demand for hybrid and electric cars is
    higher than ever, but demand for diesels’ the focus on gimmicks and
    not real solutions. I was reading Car and Driver at the doctors
    office this morning comparing a VW hybrid and diesels in the May 2011
    issues..

     

    Silly me
    but I looked at the statistics. I can buy 3 new Corollas that get
    twice the mpg as the the VW hybrid and diesels. I have never had a
    problem find economical transportation in the US.

     

    The point
    here is that there is a different dynamic than cost that determines
    what people buy. Ego more than rational thinking rules car
    purchases. What does my German expat drive in the US? A big Jeep
    SUV. Why? He likes to hunt and go hiking. I understand that but I
    do not think making fuel more expensive with tax will change that.

     

    It is
    simple. We need to increase domestic production of of fuel in a way
    that does not require consumers to change.

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  3. By savro on April 18, 2011 at 11:35 am

    Kit P said:

    The point here is that there is a different dynamic than cost that determines what people buy. Ego more than rational thinking rules car purchases. What does my German expat drive in the US? A big Jeep SUV. Why? He likes to hunt and go hiking. I understand that but I do not think making fuel more expensive with tax will change that.

    I couldn’t disagree more. Large/heavy vehicle owners would be the first to cut back if gas was selling at $6, $7 or $8 a gallon. The ones that purchased it for the looks and their hobbies — not for their job — would be the quickest to make the change.

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  4. By Benny BND Cole on April 18, 2011 at 12:51 pm

    Far and away the best energy commentator in America is Robert Rapier.

    And yes, the price signal is our friend, and yes both the left-wing and the right-wing seemed trapped by ideologoy and ossified partisan sentiments.

    My own guess, and dear hope, is that the USA emerges cleaner, stronger and more prosperous in a world where conventional crude is pricier. We will import less oil, and use more natural gas, or conserve. If oil can be sustained above $100 (or if we America get a clue and start taxing gasoline) then the PHEV has a future too.

    If Rufus shows up he will explain how we will all be saved by corn ethanol.

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  5. By rrapier on April 18, 2011 at 1:44 pm

    J.R. Ewing said:

    Robert –

    Aren’t such price signals the entire point behind programs like the Low Carbon Fuel Standard?


     

    It is, but I think programs like that are an inefficient way to accomplish the goal. For instance, what is the counter-charge by opponents of the LCFS? “You are going to raise the price of fuel.” Of course that is what it would do, but instead of simply being honest and saying “We need to raise the cost of fuel” they try to do it in a way that allows too much political posturing.

    More importantly, though, is that I think the LCFS will raise the cost of fuel without the sorts of offsets I would propose that would ensure that the higher costs don’t hurt consumers because their income taxes would be reduced.

    RR

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  6. By doggydogworld on April 18, 2011 at 1:50 pm

    Energy is cheap, except for oil. A usable kWh of energy from coal costs a couple cents. Wind, nuke, and natgas are around a nickel. But we pay 65 cents per usable kWh from oil, and since the bulk of our oil is imported most of that money goes to other countries. This insane situation exists because we refuse to move away from a legacy tranportation infrastructure that is completely dependent on oil.

    Until we force expensive imported oil to compete against cheap domestic fuels the situation will persist. With minimal effort we could convert trucking to NG and with moderate effort switch most of our car miles to electricity. But this requires a national program. Laissez-faire will not cut it because oil exporters are not laissez-faire capitalists and do not play by free market rules. Instead they use oil to further their national interests and join in illegal cartels to increase their power. Until we, the world’s largest oil importer, wise up and treat oil as strategically as the exporters do we will make no progress.

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  7. By Kit P on April 18, 2011 at 5:30 pm

    “I couldn’t disagree more. Large/heavy vehicle owners would be the first to cut back if gas was selling at $6,..”

     

    What is that based on Sam?  Sounds like a good and logical theory.  When you look out the window at the parking lot where you work how many large POVs do you see?  I stopped counting at 20.  None of these folks are worried about the cost of fuel.

     

    I had to travel through a medium size city on business so I asked someone I trusted where I could get find a good restaurant that served seafood because at my destination, seafood is all you can eat deep fried catfish (great for family dinning).  My swordfish dinner was $27.

     

    So Sam, what does a swordfish dinner cost in NYC?  Or for that matter, to park your car or get a cup of coffee?  How about a root canal?

     

    “Energy is cheap, except for oil.”

     

    No, oil is cheap.  A long time ago I mowed the lawn without the aid of an internal combustion engine.  I can mow the lawn all summer with $4 of gas.  When you start looking for ways to save money, peak coffee looks like a bigger problem than peak oil.  

     

    “But this requires a national program.”

     

    I am still thinking that I am the only one here who has bothered to read it.  Here is the problem doggydogworld, the previous speaker of the house is against domestic production and favors higher energy taxes and CAFÉ standards.  She also favors having a private jet at government expense.   

     

    Oil is a cheap commodity on the world market.  I have a hard time believing folks who warn of peak oil or AGW but live a life of excess.  Everyone should conserve but them.

     

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  8. By Wendell Mercantile on April 18, 2011 at 5:46 pm

    What is that based on Sam?

    Kit P.

    That is intuitively obvious to even the most casual observers. Sales of heavy pickup trucks and SUVs plummeted in 2008 during the most recent motor fuel price spike. That in turn led to the money flow problems GM and Chrysler had which caused them to go the Federal government asking for bailouts.

    Will there be some people who continue to buy SUVs no matter how dear fuel becomes? Yes, there will be a few. But high fuel prices will change permanently the types of vehicles the majority of people buy.

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  9. By savro on April 18, 2011 at 5:53 pm

    Kit P said:

    “I couldn’t disagree more. Large/heavy vehicle owners would be the first to cut back if gas was selling at $6,..”

     

    What is that based on Sam?  Sounds like a good and logical theory.  When you look out the window at the parking lot where you work how many large POVs do you see?  I stopped counting at 20.  None of these folks are worried about the cost of fuel.

    Statistics have shown that as gas prices rise, hybrid and fuel efficent vehicle sales go up at the expense of larger cars and SUVs. It’s hard to argue with that. But my main point is not what we see now, but the effect we would see if prices climbed to about double what we’re paying now. I can’t speak specifically of your friend and his Jeep, but I find it hard to believe that many in his position wouldn’t seriously contemplate trading in their large Jeeps for something more fuel-efficient if it costed $150 or so to fill up their tank. I’m willing to wager that $7 a gallon gas would have enough of an impact that you’d notice the change by looking out your window.

    When you start looking for ways to save money, peak coffee looks like a bigger problem than peak oil.

    I don’t know if you’ve seen Paul’s followup to what started out as a satirical post, but peak coffee is for real!

     

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  10. By rate-crimes on April 18, 2011 at 6:50 pm

    “Americans are rich because we are very productive in part because we use energy so efficiently. This is hard to see for those who just focus on energy. [emphasis mine]” – Kit P

    A brief focus on energy efficiency…

    Estimated U.S. Energy Use in 2009

    Estimated U.S. Energy Use in 2009

    54.64 quads of rejected energy out of ~94.6 quads (58%).

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  11. By Walt on April 18, 2011 at 9:08 pm

    This is interesting…

    “Talking about the low-carbon economy, in our post-Fukushima world, the
    natural gas industry has every reason to feel it will emerge as the only
    credible “bridging fuel” in the transition to the climate-friendly
    future. But, wonders Marcel Viëtor of the German Council on Foreign
    Relations, has the gas industry thought about what will happen once they
    get to the other side of the bridge? He believes the sector should
    perhaps not celebrate too soon. You can read Marcel’s friendly warning
    by clicking here.”

     

    I’m waiting for RR to give us his thoughts about the “post-Fukushima world” as this could be worth the research.

     

    I find their commentaries some of the best out of europe…subscribe if interested…I’m not affiliated in any way.

    Welcome to European Energy Review, Europe’s foremost independent
    energy journal on the internet. European Energy Review features
    original reports, interviews, analyses, viewpoints and debates from
    across Europe. Registration to our newsletter, which is free and without
    obligations, gives you full and free access to our website.

    http://www.europeanenergyrevie…..hp?id=1491

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  12. By Wendell Mercantile on April 18, 2011 at 10:57 pm

    What is that based on…

    Kit P.

    From the National Bureau of Economic Research: Pain at the Pump: The Differential Effect of Gasoline Prices on New and Used Automobile Markets

    We find that a $1 increase in gasoline price changes the market shares of the most and least fuel-efficient quartiles of new cars by +20% and -24%, respectively.

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  13. By tennie davis on April 19, 2011 at 2:21 am

    Adjusted for inflation gasoline is a bit higher now than 1981 and 1918!
    As a % of disposable income (if you have job) it’s not that expensive.
    Av. wage now (if you have job) $18 ish?
    1981 av. wage (if you had job) &7 ish?
    1918 av. wage not much? (life expectancy 53 ish)
    Bottem line-we may have a double-dip recession, but it’s not the end of the world for OECD countries.
    Remember we’re all in this together.

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  14. By tennie davis on April 19, 2011 at 2:31 am

    Now if I could just type or spell;)

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  15. By Walt on April 19, 2011 at 3:42 am

    Robert Rapier said:

    Conclusion

    While consumers do respond to price hikes on fuel, the response lags, often because of a belief that prices will fall back to historical levels. Pandering politicians don’t help matters by suggesting that prices are high for reasons other than supply and demand. By doing so, many consumers are left with the belief that just as soon as our lawmakers get their hands on those speculators and oil companies fixing prices, or the environmentalists blocking development — they can continue to consume like it was still 1999.


     

    Lawmakers are not always honest, unfortunately.

    http://www.youtube.com/watch?v…..thcO_olHas

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  16. By russ on April 19, 2011 at 6:41 am

    I remember in the early 70′s my boss (the owner of the company) saying, ‘Does the government think the high gas prices will make me drive less?’ and laughing.

    He had the money and whether it cost 25$, 50$ or 100$ to fill up his Cadillac made no difference.

    Same here in Turkey today where gasoline is well over 10$ per gallon – you see plenty of big cars on the road. The average guy drives a small car – like mine – more than likely either a diesel or CNG fueled as both are cheaper per kilometer than gasoline..

    The one who has to budget will pay attention to prices for sure – the rest – no way.

     

     

     

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  17. By mac on April 21, 2011 at 12:46 am

    Robert said:

    ::”Diesels: Mainstream Competitors to Hybrids?”

    Here’s a site that covers both hybrids and diesels with up to date stats.

    http://www.hybridcars.com/hybr…..-2011.html

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  18. By Benny BND Cole on April 19, 2011 at 1:37 pm

    BTW, according to the EIA, China has more shale the the USA. And you can convert that to diesel or methanol or CNG. I see no long-term problems.

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  19. By mac on April 20, 2011 at 4:13 pm

    Hybrid Car Affordability Leaps Forward with P2 Technology

    April 19, 2011 Mostly escaping notice, a new crop of 2011 hybrids—including the Hyundai Sonata Hybrid and the Infiniti M35 Hybrid—are using a second clutch to achieve the critical goal of separating operation of the gas engine and electric motor. These new parallel two-clutch systems—hence the name P2—could provide 95 percent of the fuel efficiency benefits of an expensive two-motor system, like the one in the Toyota Prius, but at cost reductions of one-third or more. http://www.hybridcars.com/frontpage

    What does this have to do with the “Price Signal” ?

    Everything…….

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  20. By tennie davis on April 22, 2011 at 3:24 am

    Maybe a little correction to my earlier comment.
    According to consumer price index, if they are even credible……
    Average 1981 wages might be more like $15 an hour?
    Sigh….. who says economics is easy.

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  21. By Walt on April 22, 2011 at 1:09 pm

    One way to manage the higher gas prices is by more volumes of biofuels according to Europe.

    —————————————————–

    A second chance

    Biofuels have never been one of the most popular forms
    of renewable energy. Unlike solar and wind power, they have been
    strongly opposed by many environmental groups, especially the types of
    biofuel that compete with food or whose production contributes to
    deforestation. As if this was not bad enough, the biofuels market has
    also been hit hard by the economic crisis. In 2010, global supply of
    ethanol and biodiesel outpaced demand by some 5 billion litres,
    according to research from the US-based Global Biofuels Center.

     

    However, at the recent World Biofuels Market conference,
    a prominent annual gathering of the biofuel industry in Rotterdam, the
    mood was rather upbeat. For one thing, the environmental image of at
    least part of the sector is improving, thanks in part to investments in
    “second-generation” biofuels and the good reputation of Brazilian
    ethanol. At the same time, governments in Europe, North America and
    elsewhere have firmly stood by their plans to boost biofuels production.
    The current situation on the oil market will do nothing to discourage
    these efforts.

     

    Based on the various government mandates and existing
    production plans, the Global Biofuels Center forecasts that by 2020
    there will be a supply shortage of some 32 billion litres. So now the
    biofuels sector is facing a new problem: who will fill this massive
    projected shortfall? As our reporter Rudolf ten Hoedt found in
    Rotterdam, there is only one possible answer to that question. You can
    read it by clicking here.

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  22. By Walt on April 22, 2011 at 1:21 pm

    This is interesting…I don’t know if this is true about ADM, but it makes sense to me.  If only methnol had such support.

     

    ——————————————

    http://www.europeanenergyrevie…..hp?id=2926

    An acre of farm land is required to produce 400 gallons of ethanol1. A
    single tank of ethanol requires more grain than an adult consumes in a
    year. To produce 14 billion gallons of ethanol (the 2011 mandate)
    requires 35 million acres*, almost 1.5 times all the farm land in the
    state of Illinois. (To produce all our electricity by wind (1 meg
    turbines @25% efficiency, 60 acres per turbine) would require a gigantic
    wind farm three times the size of Illinois.

    *This acreage figure is only for ethanol. The quota for combined
    biofuels is 35 billion gallons. If production efficiencies are
    consistent, total farm land required would be on the order of 90 million
    acres (2.4 times). This is close to 10% of all U.S. farm land2!

    To produce 14 billion gallons of Ethanol would require 6,289,000
    trailers loaded with 5,614,875,000 bushels of corn. If each trailer is
    48ft long and placed end to end, the train would stretch almost 2.5
    times around the earth!

    The agricorp giant Archer Daniels Midland, is the largest American producer of ethanol.

    The Cato institute estimates that every dollar in ADM profit, costs the
    American taxpayer $30.00 in the form of rebates, subsidies and tax
    benefits. “The Gulf Dead Zone”. In 2010, at over 8,000 sq. mi3, the dead
    zone was larger than the state of Mass. and the largest on record. Each
    year spring rains carry nitrate and phosphate fertilizers from
    Midwestern cornfields down the Mississippi river and into the Gulf of
    Mexico. These fertilizers generate massive algal blooms on the ocean
    surface that quickly die and sink to the ocean floor. Tiny microbes
    consume the algae and deplete the available oxygen causing other ocean
    floor dwellers to suffocate. Within the affected area, the entire ocean
    food chain is impacted. This reduces both the productivity and living
    standards of the gulf fishermen. The new Mandate can only amplify this!
    The preceding effects occurred at the 10% Ethanol blend level. As the
    new Mandate is 50% larger, the damage is likely to increase an
    equivalent amount!

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  23. By BilB on April 28, 2011 at 6:04 am

    Now that Obama has presented his full birth certificate, is Trump going to make public his tax returns as he promised?

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  24. By rrapier on April 28, 2011 at 12:53 pm

    BilB said:

    Now that Obama has presented his full birth certificate, is Trump going to make public his tax returns as he promised?


     

    That was one of my first thoughts as well. But Donald is patting himself on the back, “proud” to have played a role. Someone should remind him that a week ago he claimed his investigators were in Hawaii and “shocked” at what they were finding. And this is a man who thinks he should be running the country? LOL.

    RR

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  25. By aqua225 on May 6, 2011 at 2:29 am

    Robert, your comment:

    “The long-term fatal flaw in U.S. energy policy is that it is based on delivering energy to consumers at the lowest possible cost. This sort of thinking is flawed, and it leaves us ever more vulnerable, and less-prepared as a nation for higher oil prices.”

    … terrifies me.

    I know that the oil industry is hardly a model of raw, pure capitalism in its current form, but I think getting the government further involved, by allowing it another path to unlimited taxing ability for our “well being” would be a serious mistake. I prefer the give and take of what is generally a open market internally…

    All paths of taxation we open to our government are always overexploited in the end, and the money is never appropriated in the correct areas it was originally meant to be. I think your idea is like communism: perfect on paper, but is severely prone to abuse in the real world. I vote free markets, no or minimal resource planning.

    My opinion…

     

    This I am adding post-posting:

    Additionally, getting the government onto a specific revenue stream surrounding oil based energy, will also insure that will be the only game in town. The government won’t be interested in “alternative energy” if “alternative energies” means less oil consumption.

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  26. By paul-n on May 6, 2011 at 2:59 am

    Aqua,

     

    I don’t disagree with what your are saying re taxes, and government getting carried away with them, and a free market where the  buyers and sellers of oil hash out the prices is fine except for one thing. And that is the massive volume of oil imports is a serious economic drain on the country.  In this regard using taxation to decrease an economy sapping import, and giving tax relief elsewhere within the economy, seems like a reasonable approach to me.

     

    There is some evidence the Euro governments are hooked on their energy tax revenues – but they do use it to fund all sorts of things.  That is why Euro countries have universal health care, and the US has cheap gas.

     

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