7.5.04

HOTELLING, SAMUELSON, KRUGMAN. Professor Krugman's latest column appears to have been written without reference to either of the other-named greats. (Perhaps he was in a hurry: a footnote that Bob Herbert is on vacation might suggest he's pinch-hitting.) Today's topic is oil prices.
Oil is a resource in finite supply; no major oil fields have been found since 1976, and experts suspect that there are no more to find. Some analysts argue that world production is already at or near its peak, although most say that technological progress, which allows the further exploitation of known sources like the Canadian tar sands, will allow output to rise for another decade or two. But the date of the physical peak in production isn't the really crucial question.

The question, instead, is when the trend in oil prices will turn decisively upward. That upward turn is inevitable as a growing world economy confronts a resource in limited supply. But when will it happen? Maybe it already has.
The Hotelling theorem on the rate of depletion of exhaustible resources suggests that the price will increase at the interest rate. If it isn't happening, that is evidence of the development of replacement resources, conservation, or development of new supplies. Professor Krugman recognizes there is conservation.
During the 1980's, oil consumption dropped around the world as the delayed effects of the energy crisis led to the use of more fuel-efficient cars, better insulation in homes and so on. Although economic growth led to a gradual recovery, as late as 1993 world oil consumption was only slightly higher than it had been in 1979. In the United States, oil consumption didn't regain its 1979 level until 1997.
People respond to incentives, and that response takes time.
So what should we be doing? Here's a hint: We can neither drill nor conquer our way out of the problem. Whatever we do, oil prices are going up. What we have to do is adapt.
Adaptation is easier if there aren't artificial impediments to adaptation. That's the LeChatelier-Samuelson principle at work. It is, perversely, leading to automotive fuel consumption that is probably higher than it would be in the absence of fuel economy standards for cars but not for trucks. Consider what's been happening to the sales of sport utility vehicles in the past year.
Sales of full-size sport-utility vehicles tumbled last month, and sales of some smaller, more fuel-efficient SUVs boomed in what could be a sign that higher fuel prices are hurting automakers' high-profit models.
Thus does USA Today report on the automotive market. Despite some cheerful words from the car dealers, ominous signs proliferate.
• Full-size SUVs sat on dealer lots 68 days last month compared with just 50 days a year ago, according to data analyst Power Information Network.

• Inventories of unsold big SUVs rose to about 100 days' supply in April. That's about 30 days above normal, says Gary Lapidus, auto industry analyst at Wall Street investment house Goldman Sachs. "Light-truck inventories are bloated across the board," he says.
What's going on? Here's the Detroit News from last year.
In 1999, 7 percent of large SUV owners said they would trade for something different; last year, that percentage ballooned to 35.

"People find them too big," CNW [Marketing, a research firm] chief Art Spinella said. "People are shifting to Buick Rendezvous and more wagon-based sport-utes."
So why not build station wagons, which could use automotive unibody construction rather than truck frame construction, and achieve lower fuel use and greater passenger comfort? Station wagons are covered under the automotive fuel economy standards, which are more restrictive than those on trucks. Smaller sport utility trucks use more fuel than station wagons, as well as being somewhat odd looking. Rethink the fuel economy standards, or simply abolish them and let consumers respond to incentives, and expect more, not less, conservation of gasoline, provided the real price of gasoline continues to rise.

RUNNING EXTRA: Kevin at Truck and Barter has comments on the column and a useful summary of others who have commented on it.

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