Record high oil prices have sent shock waves through the financial markets as well as our wallets. The price of oil is so influential on Wall Street that our markets have become binary: Oil goes up, stocks go down. Oil goes down, stocks go up.
But no matter how painful $100+ oil is to endure, there’s always the hope that it’s actually good for America. Alternative energy research is booming, people are becoming more “green” and, best of all, we’re buying less (albeit at a higher price) of the black gold from regimes we may not want to fund.
However, this “demand destruction” for oil isn’t leading us straight to energy independence. Instead, at least in the short-term, it’s actually making us more susceptible to supply disruptions and political risk in places like the Middle East and Russia. Therefore, oil-rich nations’ economic and political clout is further enhanced, while ours is diminished. Energy analyst Jeff Vail explains (The Oil Drum):
The basic mechanism underlying this theory is that, when forced to eliminate consumption of oil, individuals, and the market in aggregate, will eliminate the most discretionary consumption first. As a result, the remaining consumption will be more valuable to the individual, firm, or economy in terms of GDP or quality of life produced per barrel of oil consumed. This remaining demand is more inelastic. When the oil demand–whether it is for a family, industry, or nation–becomes more inelastic there is greater exposure to supply disruptions.
Basically, once the US has stripped down its oil consumption to only its most “necessary” needs, there are no bullets left in the gun. If supply is reduced (whether it be from a war, a dictator’s discretion, or simply via nature), we’re screwed. We need the oil, so we’ll have to pay for it, no matter the price.
So, what can we do if this scenario takes hold before alternative energy is a true substitute for oil?
…rather than work to create viable, stable, renewable substitutes to the more elastic components of oil demand, we would be better served by focusing subsidies and research grants on replacing our most inelastic demand first. Implement policy and subsidy as necessary to replace or eliminate the most inelastic sources of demand first–the exact opposite of what the market would do, but the best way to increase systemic resiliency.
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