As oil prices tumble — now hovering around $65 per barrel — there is growing concern that some of the momentum that was building for renewable energy may be waning. This situation highlights one of the key constraints that we face in moving to a low-carbon society: uncertainty in fossil-fuel prices depresses investments in alternative energy.
After the oil shock of the 1970s, the prediction was that alternative energy would take off, but this never materialized because oil prices subsequently plummeted, dropping below $20 a barrel for much of the 1990s.
The high this year of $147 per barrel sent shock waves through the global economy, and for the first time in decades, it led to a significant decrease in U.S. consumption of gasoline, an increase in the use of public transportation, and a switch away from large SUVs to fuel-efficient vehicles. Unfortunately, if oil prices stay low these trends may reverse.
So what is the appropriate policy response if we want to ensure that incentives exist to permanently move away from oil and other fossil fuels?
The optimum from the standpoint of the U.S. would be if the price of oil to producers were low, but remained high to consumers. This can only happen if the government imposes a significant tax on fossil fuels to create this wedge. Creating a price-floor below which the price of oil cannot fall would be the best way to create certainty for investment in alternatives and also mitigate the negative regressive affects.
For example, if oil prices fall to $50 the U.S. government should institute a tax of $50 per barrel to keep the price at $100. Instead of going to Saudi Arabia, Iran, Russia, and Venezuela this extra $50 would be in the hands of the government and could be rebated directly back to consumers (in a progressive fashion) as well as to fuel-intensive businesses.
The incentive to conserve and move away from fossil fuels would remain, but the revenue would be going to beneficial purposes instead of funding some of the world’s worst regimes. If the price of oil changed the tax would change up or down to reflect it. Economists have been advocating some variant of this policy for decades to no avail. It is time we got serious about energy policy, and maybe, just maybe, the time is right.