Why Lower Energy Prices Can Be A Mixed Blessing

From the most meaningful perspective to most Americans--that of their pocketbooks--the overall trend in energy costs in recent years has been a blessing. Energy prices rose just 2% last year, helping to hold the consumer price index to a 2.9% gain, its smallest in six years. On an inflation-adjusted basis, energy prices are not much higher today than they were in 1987. And real gasoline prices are lower than they were in the mid-1970s.

The downside to this picture is the impact on energy efficiency. In 1972, the year before foreign oil producers quadrupled the price of oil, the U.S. economy consumed 22,900 Btus of energy per dollar of gross domestic product (1987 dollars). By 1986, after more than a dozen years of painful adjustment to higher energy prices, continued emphasis on energy efficiency and conservation by consumers and business had cut U.S. usage per unit of economic output by more than 26%.

Since the oil price collapse of 1986, however, years of relatively cheap energy prices have brought the march toward greater energy efficiency to a virtual halt (chart). And that has stymied efforts to temper the indirect social and economic costs associated with energy use: increased dependence on foreign oil, which retards progress in cutting the trade deficit, and pollution and environmental damage--including the uncertain but potentially catastrophic effects of global warming.

All of this helps explain why the Clinton Administration is leaning toward some sort of energy tax, both to help cut the deficit and to move toward meeting environmental and trade goals. "The best time to impose an energy tax," says economist Mary Novak of DRI/McGraw-Hill, "is when energy prices are relatively low and quiescent."

That certainly seems to be the outlook over the next few years. Although a new oil price surge cannot be ruled out at a time of global tensions, DRI/McGraw-Hill economists believe that "the effects of stronger world demand for oil will be largely offset by increased worldwide supplies in coming years, restraining real oil prices through 1995." In fact, they warn that an oil price collapse is possible if Iraqi oil exports resume quickly and OPEC fails to cut output to accommodate their return.

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