Someone must have told the optimists that energy prices have retreated because they're starting to venture out of their caves. They're not exactly back, but we're once again being reminded that when prices go up, demand does down, and the prices will follow it back down (and then demand goes up....repeat). The New York Times had a good article this weekend about the new energy conservationism. As energy prices have gone up, people have made cutbacks to their energy usage. Refreshingly, the role of technology as an ongoing energy-reducing force is cited as being significant:
Perhaps the most important reason for optimism is technology's role in promoting energy savings. From 1979 to 1985, in the aftermath of energy shortages, Americans reduced their oil consumption by 15 percent. The single biggest factor was a shift in car-buying habits. Americans found that driving fuel-efficient cars, instead of gas guzzlers, didn't stop them from going where they wanted to go. The shift also had a big macroeconomic effect, sending world oil prices tumbling and setting the stage for two decades of low energy costs.
During those decades, energy conservation would gradually fade from public view. But higher prices are again capturing the public's attention. Big companies are finding ways to conserve energy to improve the bottom line. Last month, Wal-Mart announced a plan to cut energy use in its stores, to double the fuel efficiency of its trucks and to minimize the use of packaging. Consumers are changing their habits, too. Sales of S.U.V.'s, for example, have fallen and automakers that bet heavily on cheap energy are suffering declining fortunes.
How much more energy-efficient can we become? Amory B. Lovins, chief executive of the Rocky Mountain Institute, a nonprofit energy research group in Snowmass, Colo., says that a barrel of oil today already does twice as much work as it did in 1975. Mr. Lovins calculates that by moving to vehicles that consume less fuel, the nation could double that efficiency again.
The article mentions several other areas that can be improved. While we tend to think chiefly about automobile efficiency, merely turning off household appliances when not in use would help reduce aggregate demand by 5%.
Actually, this 5% might be understating it. Think about it like an economist. For the consumer, reducing 5% of household electricity usage is just that, a 5% lower electricity-bill. It's not particularly big, and maybe it amounts to a few dollars per month. But remember, that in a market such as this, the price per Kilowatt-Hour of energy for everyone is determined by the cost of producing the last Kilowatt of energy. It's the production at the margins that determines the cost of the whole. If everyone turned off their idling appliances, and we reduced total demand by 5% we'd take a significant step back from the edge, reducing both quantity (by .05) and price (unknown, x) and thus reducing overall electricity costs by 5%*x which might amount to something significant. Just as energy prices appreciated very rapidly when supply got tight, a small loosening could produce just as rapid a decline.
We'll see what happens, but it's nice that there's finally some debate about energy in the media instead of the usual one-sided panic.
There is no conflict in economic theory between higher prices and higher quantities.
Energy price bears tend to have a myopic focus on an inverse relationship between price and the quantity demanded. Unfortunately, this relationship is only true when considering movement of a supply curve along a static demand curve. This view seems to be colored by the history of supply disruptions in the seventies and the first Gulf War. Those events were supply disruptions, where the supply curve was forced to the left, constraining the supply to the market and raising prices along the short run demand curve. The long run demand response was a shift in the demand curve to the left and lower prices at lower quanties of demand.
Subsequent events exacerbated the price fall. The energy industry implemented 3D siesmic exploration technology, horizontal drilling, and pressure pumping, all of which drastically reduced the cost of marginal supply rates. Exploration of new wells enjoyed a step function increase in productivity at the same that existing wells increased production rates at relatively low incremental rates of investment. This rightward shift in the supply curve meant lower price and greater quantities at the same time with no complaints. Note that both the US and North Sea enjoyed increased production years after their initial peaks due to pressure pumping and horizontal drilling. Neither area reached previous highs and are in decline again.
The last five years have seen no significant technological advances, so the supply curve has been relatively static and looks to be quite steep, at least until the next major invention or discovery.
For now and excepting the hurricane disruptions, we are experiencing gradual growth in demand (curve shifting right). This movement along the supply curve yields higher prices and higher quantities demanded at the same time.
On another but similar note, we do have a refining problem in the US. Higher crude prices are evidence of this. All crudes are not the same. World production of light, sweet crude peaked four years ago. Since refineries produce less high grade product (gas, jet fuel, diesel) per barrel of crude when the crude is heavier and more sour, refining output capacity has gotten tighter. This has lead to the huge run up in price for benchmark light sweet grade and record spreads between light sweet and heavy sour.
I'm getting tired of typing, but the run up in nat gas price hasn't helped either. There is some overlap between crude based fuel use and nat gas use, so the failure to produce more nat gas despite record drilling in the US, is helping keep crude fuel prices high.
Love your blog.
Posted by: Jason | November 14, 2005 at 02:55 PM
i have a problem regarding the demand for electricity. i have researched that as prices of electricty increases, quantity demanded also INCREASE. which is very contrasting to alfred marshal's law of demand.can u help me why is that so?
Posted by: frances dumas | January 24, 2007 at 12:25 AM