Climate Change and the Deficit

Over at the National Journal’s Economy blog, John Maggs asks some budget experts for recommendations of how President Obama can bring the budget deficit down by 2016.

Here’s an excerpt from my contribution:

President Obama should combine his concern about climate change with his concern about the budget. …  President Obama should demand … that any climate change bill achieve significant deficit reduction. For example, he could refuse to sign any cap-and-trade bill unless it auctions a large fraction of the allowances and dedicates the resulting revenues to deficit reduction. … A reasonable approach could easily reduce deficits by $300 to $400 billion over the next ten years, including both the value of the allowances and lower interest payments.

Another Look at Oil and Natural Gas Prices

A couple weeks ago, I discussed the remarkable divergence between the prices of oil and natural gas. At the time, the spot price of West Texas Intermediate was above $73 per barrel, while the spot price of natural gas at the Henry Hub was about $3 per MMBtu. The ratio of the two prices was at record levels, with the oil price 24.5 times the natural gas price.

Oil prices have declined since then, closing at $68.24 per barrel yesterday. But natural gas prices have also declined, closing at $2.82. As a result, the price ratio remains above 24, much higher than the 6 to 12 that’s been normal in recent decades.

To provide some more insight into what’s going on, I made a new graph to show the path of oil and natural gas prices since the start of 2001:

Natural Gas and Oil Prices - Sep 1 2009

The chart (squiggle, if you prefer) tracks the path of monthly average oil prices along the horizontal axis and monthly average natural gas prices along the vertical, plus yesterday’s closing data. Several features of the graph leap out:

Continue reading “Another Look at Oil and Natural Gas Prices”

Dodging the Resource Curse

Over the weekend, the Financial Times had a fascinating piece about Farouk al-Kasim, an Iraqi who is credited with saving Norway from the resource curse:

Poor countries dream of finding oil like poor people fantasise about winning the lottery. But the dream often turns into a nightmare as new oil exporters realise that their treasure brings more trouble than help. Juan Pablo Pérez Alfonso, one time Venezuelan oil minister, likened oil to “the devil’s excrement”. Sheikh Ahmed Yamani, his Saudi Arabian counterpart, reportedly said: “I wish we had found water.”

Such resignation reflects bitter experience of the way that dependency on natural resources can poison a country’s economic and political system. Inflows of hard currency push up prices, squeezing the competitiveness of non-oil businesses and starving them of capital. As a result, productivity growth withers (a phenomenon known as “Dutch disease” after the negative effects of North Sea gas production on the Netherlands). Meanwhile, the state institutions in charge of oil often become corrupt and evade democratic control. And oil-rich states almost invariably waste the income it brings, many ending their oil booms deeper in debt than when they started.

al-Kasim is credited with designing a system that struck a balance among a state-owned oil company, private oil companies, and an independent regulator:

The real achievement, in other words, was not finding oil but coping with its discovery. Norway faced the same dilemma as every other new oil producer with no experience of the industry: if you rely too much on private foreign companies, too little of the oil wealth benefits the country in the form of government revenue or economic development; if you go too far in the other direction, you risk a bloated, politicised oil sector that evades both accountability to the people and competitive pressures to be efficient.

The economic question is fascinating — how can you avoid the resource curse? — but you should also read the article for his unique personal journey (involving a child with cerebral palsy and one of the easiest job hunts in history).

P.S. Other coverage at Curious Capitalist and Kottke.

The Disconnect Between Oil and Natural Gas Prices

Yesterday marked a new record in the divergence between oil and natural gas prices.

As noted in a small item in the Wall Street Journal, the ratio of oil prices ($ per barrel) to natural gas prices ($ per million BTU) hit a record 24.5 at yesterday’s close. As you can see from the following chart, that’s far out of line with historical norms:

Ratio of Oil to NG (August 21 2009)

A barrel of oil has roughly 6 times the energy content of a MMBtu of natural gas. If the fuels were perfect substitutes, oil prices would tend to to be about 6 times natural gas prices. In practice, however, the ease of using oil for making gasoline makes oil more valuable. As a result, oil has usually traded between 6 and 12 times the price of natural gas.

That’s changed in recent months. Natural gas prices have fallen to $3.00 per MMBtu, weighed down by new supply and weak demand. Oil prices, however, have stubbornly increased to more than $70 per barrel. That’s down sharply from the $100+ prices of last year, but up sharply from the $40 – $50 range earlier this year.

Where do prices go from here?

Continue reading “The Disconnect Between Oil and Natural Gas Prices”

Big Money in Cap-and-Trade

On Friday, the House of Representatives passed its climate change bill by a slim margin. The bill’s key feature is a cap-and-trade system for greenhouse gases. That system would set national emission limits and would require affected emitters to own permits (called allowances) to cover their emissions.

The number one thing you should know about this bill is that the allowances are worth big money: almost $1 trillion over the next decade, according to the Congressional Budget Office, and more in subsequent decades.

There are many good things the government could do with that kind of money. Perhaps reduce out-of-control deficits? Or pay for expanding health coverage? Or maybe, as many economists have suggested, reduce payroll taxes and corporate income taxes to offset the macroeconomic costs of limiting greenhouse gases?

Choosing among those options would be a worthy policy debate. Except for one thing: the House bill would give away most of the allowances for free. And it spends virtually all the revenue that comes from allowance auctions.

As a result, the budget hawks, health expanders, and pro-growth forces have only crumbs to bargain over. From a budgeteer’s perspective, the House bill is a disaster.

The following table illustrates how much revenue the bill would raise and compares it to the alternative of auctioning all the allowances:

Cap-and-trade revenues

Continue reading “Big Money in Cap-and-Trade”