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The Sunday Telegraph:'Nonsense, nonsense, nonsense: the myths about high oil prices

Nonsense, nonsense, nonsense: the myths about high oil prices
By Niall Ferguson
(Filed: 30/04/2006)

The British call it petrol, Americans prefer gasoline. But whatever you call it, prices at the pump are soaring. Last week gas hit $3 a gallon in some parts of the United States. To which British motorists can only reply: Diddums.

Driving down the M40 on Friday, I passed petrol stations selling regular unleaded at 97.9 pence per litre. That works out at $6.62 a gallon. If a British outlet offered petrol at American prices – 44 pence a litre – there would be a queue from Beaconsfield to Birmingham.

It's no great mystery why the British shell out more than double what Americans pay to fill up their cars. For years the United Kingdom has levied much higher taxes on fossil fuels than the United States. So if British motorists want to blame someone for the high cost of motoring, they know where to start.

Of course, it's not Gordon Brown's fault that the underlying price of petrol has risen steeply since he came into office. Crude oil futures hit a record price of $75 a barrel last week. That's six times the price that producers were asking back in December 1998.

So who's to blame for higher oil prices? This week, we have heard nearly all the usual suspects fingered, along with some new ones. “We are dealing not just with normal supply and demand economics,” Lord Browne, the chief executive of BP explained in an interview. “Financial activity in the oil markets” was driving prices up, one of his colleagues explained, a thinly-veiled reference to hedge funds.

American politicians offered a less subtle story. Leading Democrats blamed President Bush for being too “cosy with the oil industry”. Those who previously argued that the Bush administration invaded Iraq to make oil cheap now argue that it was in fact, er, to make oil dear.

The Chancellor? The hedge funds? The oil companies? I'm surprised someone hasn't yet blamed the Deputy Prime Minister, John Prescott, who famously keeps two Jaguars – one (it now turns out) for each of the women in his life.

This blame game is a farce. The price of fuel is high precisely because of “supply and demand economics”, as Lord Browne knows only too well. Global demand for oil has risen by around 40 per cent in the past 20 years. As so often in world economic affairs these days, a crucial role is being played by China. In the last five years, the G7 countries have accounted for just 15 per cent of the growth in global demand; China has accounted for twice that.

Soaring demand is coinciding with stagnant supply. Global refining capacity has scarcely grown and took a big knock from last year's hurricanes. Meanwhile, political instability in some of the world's principal oil producing countries – Iraq, Nigeria and Venezuela – has made commodity traders and intelligent investors legitimately pessimistic about future supply. And let's not forget the possibility of US air strikes against Iran. It's hardly “speculation” to bid up the price of oil futures. Only a fool is “short oil” these days.

Could we be about to relive the 1970s, which was the last time oil prices were this high relative to other consumer prices? The good news is that, thanks to increased efficiency and reduced industry, the G7 economies are much less oil-dependent than they were back in the days of kipper ties and bell-bottoms. Nor are high oil prices likely to bring back the stagflation – low growth plus high inflation – we saw in those dreary days.

Some analysts even argue that high oil prices are good, on the principle that they send a signal to producers and consumers that it is time to seek new sources of energy. But this is another piece of nonsense.

There are two problems with high oil prices. The first is political: they enrich the wrong people. “Naturally Iran is happy,” the Iranian oil minister was quoted as saying by al-Jazeera last week. “High prices make any supplier happy.” Well, anything that makes the regime in Teheran happy is bad in my book.

But the much more serious problem is environmental. Here, I have to dissent from the fashionably contrarian view that global warming isn't happening or doesn't matter. For 400,000 years, the world's atmospheric concentration of carbon dioxide (CO2) fluctuated between 180 and 280 parts per million (ppm). Last year it reached 380 ppm. The evidence that global temperatures are rising as a result is incontrovertible. True, no one knows exactly what the effects on the world's climate may be. But, once again, only a fool thinks there will be no effects.

The trouble is that high oil prices are not a signal to mankind to do anything about CO2 emissions. On the contrary, they are as much a signal for oil companies to exploit hitherto non-viable deposits of hydrocarbons, such as Canada's tar sands. At the same time, high oil prices do not deter people from buying gas-guzzling cars. Indeed, the demand for Sports Utility Vehicles like the monstrous Hummer seems to be (as economists say) “price-inelastic”. Better-off Americans are still buying Hummers even with gas at $3 a gallon.

It's easy to see why. If you drive as much as Americans do – it's a big country and people commute long distances to work – you want to be comfortable on the road. The SUV is in fact a kind of hybrid – part vehicle, part living room. Unfortunately, the market is only as far-sighted as consumers. If people don't believe that global warming will affect their lives – and polls show that they don't – then the risk of climate change simply isn't priced in.

So what is to be done? Is there a better way to propel ourselves around than sucking oil out of the ground, refining it and setting it alight in internal combustion engines? The answer is yes.

I've often agreed with Homer Simpson that alcohol is the solution to (as well as the cause of) most of life's problems. In this case, alcohol really is the answer – to be precise, the form of alcohol known as ethanol, which is distilled from plants such as sugar cane.

Unnoticed in the northern hemisphere, one country is pioneering a transportation revolution by switching from petrol to ethanol. That country is Brazil. Today, ethanol accounts for 40 per cent of all automobile fuel in Brazil, while 80 per cent of new Brazilian cars are flexible-fuel cars that can run on either petrol or ethanol.

In theory, such “biomass” fuels – derived from carbohydrates not hydrocarbons – could replace nearly all of the world's oil-based transportation fuels. There would be some environmental costs to such a switch, no doubt, but it would radically curtail CO2 emissions.

What's preventing the northern hemisphere from following Brazil's lead? The answer is not so much Big Oil – though American oil companies have fought tooth and nail against the introduction of ethanol, even as a fuel additive – as Small Agriculture. To protect northern farmers, huge tariffs are currently imposed on imports of Brazilian-produced ethanol by both the United States and the European Union.

Yet not even a world of perfect free trade would convert humanity to more prudent forms of propulsion. Tax incentives are also needed to encourage people to buy flexible-fuel cars.

And if you want to know how to pay for those tax breaks, just ask Gordon Brown. British-style taxation of gasoline won't stop Americans from driving Hummers. But it could help finance a transition to the car of the future: Green Hummers that run on booze.

• Niall Ferguson is Laurence A. Tisch Professor of History at Harvard University

© Niall Ferguson, 2006

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