EnergyThe future of energy

A fundamental change is coming sooner thanyou might think

SINCE the industrial revolution 200 yearsago, mankind has depended on fossil fuel. Thenotion that this might change is hard tocontemplate. Greens may hector. Consciencesmay nag. The central heating's thermostat mayturn down a notch or two. A less thirsty carmay sit in the drive. But actually stop usingthe stuff? Impossible to imagine: surelythere isn't a serious alternative?Such a failure of imagination has been at theheart of the debate about climate change. Thegreen message—use less energy—is not going tosolve the problem unless economic growthstops at the same time. If it does not (andit won't), any efficiency saving will soon beeaten up by higher consumption per head. Eventhe hair-shirt option, then, will bring onlyshort-term relief. And when a dire prophecyfrom environmentalism's jeremiad looks as ifit is coming true, as the price of petroleumrises through the roof and the idea that oilmight run out is no longer whispered incorners but openly discussed, there is atemptation to believe that the end of the

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world is, indeed, nigh. Not everyone,however, is so pessimistic. For, in theimaginations of a coterie of physicists,biologists and engineers, an alternativeworld is taking shape. There are plans forthe end of the fossil-fuel economy are nowbeing laid and they do not involve much self-flagellation. Instead of bullying and scaringpeople, the prophets of energy technology areattempting to seduce them. They promise aworld where, at one level, things will havechanged beyond recognition, but at anotherwill have stayed comfortably the same, andmay even have got better.This time it's seriousAlternative energy sounds like a cop-out.Windmills and solar cells hardly seem likeways of producing enough electricity to powera busy, self-interested world, as furnacesand steam-turbines now do. Battery-poweredcars, meanwhile, are slightly comic: morelike milk-floats than Maseratis. But theproponents of the new alternatives areserious. Though many are interested inenvironmental benefits, their main motive ismoney. They are investing their cash in ideasthat they think will make them large amountsmore. And for the alternatives to do that,they need to be both as cheap as (or cheaperthan) and as easy to use as (or easier than)what they are replacing.

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For oil replacements, cheap suddenly looksless of a problem. The biofuels or batteriesthat will power cars in the alternativefuture should beat petrol at today's prices.Of course, today's prices are not tomorrow's.The price of oil may fall; but so will theprice of biofuels, as innovation improvescrops, manufacturing processes and fuels. Electrical energy, meanwhile, will remaincheaper than petrol energy in almost anyforeseeable future, and tomorrow's electriccars will be as easy to fill with juice froma socket as today's are with petrol from apump. Unlike cars powered by hydrogen fuelcells, of the sort launched by Honda thisweek, battery cars do not need new pipes todeliver their energy. The existing grid,tweaked and smartened to make better use ofits power stations, should be infrastructureenough. What matters is the nature of thosepower stations.The price is rightThey, too, are more and more likely to bealternative. Wind power is taking on naturalgas, which has risen in price in sympathywith oil. Wind is closing in on the price ofcoal, as well. Solar energy is a few yearsbehind, but the most modern systems alreadypromise wind-like prices. Indeed, bothindustries are so successful thatmanufacturers cannot keep up, and supply

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bottlenecks are forcing prices higher thanthey otherwise would be. It would help ifcoal—the cheapest fuel for making electricity—were taxed to pay for the climate-changingeffects of the carbon dioxide produced whenit burns, but even without such a tax, someambitious entrepreneurs are already talkingof alternatives that are cheaper than coal.Older, more cynical hands may find thisdisturbingly familiar. The last time suchalternatives were widely discussed was duringthe early 1970s. Then, too, a spike in theprice of oil coincided with a fear thatnatural limits to supply were close. Thenewspapers were full of articles on solarpower, fusion and converting the economy torun on fuel cells and hydrogen.Of course, there was no geological shortageof oil, just a politically manipulated one.Nor is there a geological shortage this timeround. But that does not matter, for thereare two differences between then and now. Thefirst is that this price rise is driven bydemand. More energy is needed all round. Thatgives alternatives a real opening. The secondis that 35 years have winnowed thetechnological wheat from the chaff. Fewbelieve in fusion now, though uranium-poweredfission reactors may be coming back intofashion. And, despite Honda's launch, theidea of a hydrogen economy is also fading

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fast. Thirty-five years of improvements have,however, made wind, solar power and high-techbatteries attractive. As these alternatives start to roll out inearnest, their rise, optimists hope, willbecome inexorable. Economies of scale willdevelop and armies of engineers will tweakthem to make them better and cheaper still.Some, indeed, think alternative energy willbe the basis of a boom bigger thaninformation technology.Whether that boom will happen quickly enoughto stop the concentration of carbon dioxidein the atmosphere reaching dangerous levelsis moot. But without alternative energysources such a rise is certain. The bestthing that rich-world governments can do isto encourage the alternatives by taxingcarbon (even knowing that places like Chinaand India will not) and removing subsidiesthat favour fossil fuels. Competition shoulddo the rest—for the fledgling firms of thealternative-energy industry are incompetition with each other as much as theyare with the incumbent fossil-fuel companies.Let a hundred flowers bloom. When they have,China, too, may find some it likes the lookof. Therein lies the best hope for the energybusiness, and the planet.

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The next technology boom may well be based onalternative energy, says Geoffrey Carr(interviewed here). But which sort to back?

EVERYONE loves a booming market, and mostbooms happen on the back of technologicalchange. The world’s venture capitalists,having fed on the computing boom of the1980s, the internet boom of the 1990s and thebiotech and nanotech boomlets of the early2000s, are now looking around for the nextone. They think they have found it: energy. Many past booms have been energy-fed: coal-fired steam power, oil-fired internal-combustion engines, the rise of electricity,even the mass tourism of the jet era. But thepast few decades have been quiet on thatfront. Coal has been cheap. Natural gas hasbeen cheap. The 1970s aside, oil has beencheap. The one real novelty, nuclear power,went spectacularly off the rails. Thepressure to innovate has been minimal.In the space of a couple of years, all thathas changed. Oil is no longer cheap; indeed,it has never been more expensive. Moreover,there is growing concern that the supply ofoil may soon peak as consumption continues togrow, known supplies run out and new reservesbecome harder to find. The idea of growing what you put in the tankof your car, rather than sucking it out of a

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hole in the ground, no longer looks likeeconomic madness. Nor does the idea ofthrowing away the tank and plugging your carinto an electric socket instead. Much of theworld’s oil is in the hands of governmentswho have little sympathy with the rich West.When a former head of America’s CentralIntelligence Agency allies himself with tree-hugging greens that his outfit would oncehave suspected of subversion, you knowsomething is up. Yet that is one tack JamesWoolsey is trying in order to reduce hiscountry’s dependence on imported oil.The price of natural gas, too, has risen insympathy with oil. That is putting up thecost of electricity. Wind- and solar-poweredalternatives no longer look so costly bycomparison. It is true that coal remainscheap, and is the favoured fuel for powerstations in industrialising Asia. But therich world sees things differently. In theory, there is a long queue of coal-fired power stations waiting to be built inAmerica. But few have been completed in thepast 15 years and many in that queue havebeen put on hold or withdrawn, for tworeasons. First, Americans have becomeintolerant of large, polluting industrialplants on their doorsteps. Second, Americanpower companies are fearful that they willsoon have to pay for one particular

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pollutant, carbon dioxide, as is starting tohappen in other parts of the rich world.Having invested heavily in gas-firedstations, only to find themselves locked intoan increasingly expensive fuel, they do notwant to make another mistake. That has opened up a capacity gap and anopportunity for wind and sunlight. The futureprice of these resources—zero—is known. Thatcertainty has economic value as a hedge, evenif the capital cost of wind and solar powerstations is, at the moment, higher than thatof coal-fired ones.The reasons for the boom, then, are tangled,and the way they are perceived may change.Global warming, a long-range phenomenon, maynot be uppermost in people’s minds during aneconomic downturn. High fuel prices may fallas new sources of supply are exploited tofill rising demand from Asia. Security ofsupply may improve if hostile governments arereplaced by friendly ones and sources becomemore diversified. But none of the reasons islikely to go away entirely. Global warming certainly will not. “Peakoil”, if oil means the traditional sort thatcomes cheaply out of holes in the ground,probably will arrive soon. There is oilaplenty of other sorts (tar sands, liquefiedcoal and so on), so the stuff is unlikely torun out for a long time yet. But it will get

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more expensive to produce, putting a floor onthe price that is way above today’s. Andpolitical risk will always be there—particularly for oil, which is so oftenassociated with bad government for the simplereason that its very presence causes badgovernment in states that do not have stronginstitutions to curb their politicians.A prize beyond the dreams of avariceThe market for energy is huge. At present,the world’s population consumes about 15terawatts of power. (A terawatt is 1,000gigawatts, and a gigawatt is the capacity ofthe largest sort of coal-fired powerstation.) That translates into a businessworth $6 trillion a year—about a tenth of theworld’s economic output—according to JohnDoerr, a venture capitalist who is heavilyinvolved in the industry. And by 2050, powerconsumption is likely to have risen to 30terawatts.Scale is one of the important differencesbetween the coming energy boom, if itmaterialises, and its recent predecessors—particularly those that relied on informationtechnology, a market measured in merehundreds of billions. Another difference isthat new information technologies tend to bedisruptive, forcing the replacement ofexisting equipment, whereas, say, building

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wind farms does not force the closure ofcoal-fired power stations.

For both of these reasons, any transitionfrom an economy based on fossil fuels to onebased on renewable, alternative, green energy—call it what you will—is likely to be slow,as similar changes have been in the past (seechart 1). On the other hand, the scale of themarket provides opportunities foralternatives to prove themselves at themargin and then move into the mainstream, asis happening with wind power at the moment.And some energy technologies do have thepotential to be disruptive. Plug-in cars, forexample, could be fuelled with electricity ata price equivalent to 25 cents a litre ofpetrol. That could shake up the oil,carmaking and electricity industries all inone go.The innovation lull of the past few decadesalso provides opportunities for technological

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leapfrogging. Indeed, it may be that thefield of energy gives the not-quite-booms inbiotechnology and nanotechnology theindustrial applications they need to growreally big, and that the three aspiring boomswill thus merge into one.The possibility of thus recapturing the goodtimes of their youth has brought many well-known members of the “technorati” out oftheir homes in places like Woodside,California. Energy has become supercool. ElonMusk, who co-founded PayPal, has developed abattery-powered sports car. Larry Page andSergey Brin, the founders of Google, havestarted an outfit called Google.org that issearching for a way to make renewable energytruly cheaper than coal (or RE<C, as theydescribe it to their fellow geeks). Vinod Khosla, one of the founders of SunMicrosystems, is turning his considerableskills as a venture capitalist towardsrenewable energy, as are Robert Metcalfe, whoinvented the ethernet system used to connectcomputers together in local networks, and MrDoerr, who works at Kleiner Perkins Caufield& Byers, one of Silicon Valley’s best-knownventure-capital firms. Sir Richard Branson,too, is getting in on the act with his VirginGreen Fund. This renewed interest in energy is bringingforth a raft of ideas, some bright, some

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batty, that is indeed reminiscent of thedotcom boom. As happened in that boom, mostof these ideas will come to naught. But therecould just be a PayPal or a Google or a Sunamong them.More traditional companies are also taking aninterest. General Electric (GE), a largeAmerican engineering firm, already has athriving wind-turbine business and is gearingup its solar-energy business. The energyresearchers at its laboratories inSchenectady, New York, enjoy much of theintellectual freedom associated with start-upfirms, combined with a secure supply ofmoney.Meanwhile, BP and Shell, two of the world’sbiggest oil companies, are sponsoring bothacademic researchers and new, small firmswith bright ideas, as is DuPont, one of thebiggest chemical companies. Not everyone hasjoined in. Exxon Mobil, the world’s largestoil company not in government hands, isconspicuously absent. But in many boardroomsrenewables are no longer seen as just a wayof keeping environmentalists off companies’backs.

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Some people complain that many existing formsof renewable energy rely on subsidies orother forms of special treatment for theirviability. On the surface, that is true. Lookbeneath, though, and the whole energy sectoris riddled with subsidies, both explicit andhidden, and costs that are not properlyaccounted for. Drawing on the work of peoplelike Boyden Gray, a former White Housecounsel, Mr Woolsey estimates that Americanoil companies receive preferential treatmentfrom their government worth more than $250billion a year. And the IntergovernmentalPanel on Climate Change (IPCC), a UnitedNations-appointed group of scientificexperts, reckons that fossil fuels should

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carry a tax of $20-50 for every tonne ofcarbon dioxide they generate in order to payfor the environmental effects of burning them(hence the fears of the power-generators). So the subsidies and mandates offered torenewable sources of power such as windturbines often just level the playing field.It is true that some subsidies amount tounwarranted market-rigging: examples includethose handed by cloudy Germany to its solar-power industry and by America to its maize-based ethanol farmers when Brazilian sugar-based ethanol is far cheaper. Others, though,such as a requirement that a certainproportion of electricity be derived fromnon-fossil-fuel sources, make no attempt topick particular technological winners. Theymerely act to stimulate innovation byguaranteeing a market to things that actuallywork.If the world were rational, all of thesemeasures would be swept away and replaced bya proper tax on carbon—as is starting tohappen in Europe, where the price arrived atby the cap-and-trade system being introducedis close to the IPCC’s recommendation. Ifthat occurred, wind-based electricity wouldalready be competitive with fossil fuels andothers would be coming close. Failing that,special treatment for alternatives isprobably the least bad option—though such

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measures need to be crafted in ways thatfavour neither incumbents nor particular waysof doing things, and need to be withdrawnwhen they are no longer necessary.

The poor world turns greener too

That, at least, is the view from the richworld. But poorer, rapidly developingcountries are also taking more of an interestin renewable energy sources, despiteassertions to the contrary by some Westernpoliticians and businessmen. It is true thatChina is building coal-fired power stationsat a blazing rate. But it also has a largewind-generation capacity, which is expectedto grow by two-thirds this year, and is theworld’s second-largest manufacturer of solarpanels—not to mention having the largestnumber of solar-heated rooftop hot-watersystems in its buildings. Brazil, meanwhile, has the world’s second-largest (just behind America) and mosteconomically honest biofuel industry, whichalready provides 40% of the fuel consumed byits cars and should soon supply 15% of itselectricity, too (through the burning ofsugarcane waste). South Africa is leading theeffort to develop a new class of safe andsimple nuclear reactor—not renewable energyin the strict sense, but carbon-free and thus

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increasingly welcome. These countries, andothers like them, are prepared to look beyondfossil fuels. They will get their energywhere they can. So if renewables and otheralternatives can compete on cost, the poorand the rich world alike will adopt them.That, however, requires innovation. Suchinnovation is most likely to come out of thelaboratories of rich countries. At a recentdebate at Columbia University, which TheEconomist helped to organise, Mr Khosladefended the proposition, “The United Stateswill solve the climate-change problem”. TheCalifornian venture capitalist argued that ifcheaper alternatives to fossil fuels aredeveloped, simple economics will ensure theiradoption throughout the world. He alsoinsisted that the innovation which willcreate those alternatives will come almostentirely out of America. As it happens, he lost. But that does notmean he is wrong. There are lots of terawattsto play for and lots of money to be made. Andif the planet happens to be saved on the way,that is all to the good.Energy

Double, double, oil and troubleIs it “peak oil” or a speculative bubble?Neither, really

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AFTER oil hit its recent record of $135 abarrel, consumers and politicians started tolash out in every direction. Fishermen inFrance have been blockading ports and pouringoil on the roads in protest. British lorrydrivers have paraded coffins through Londonas a token of the imminent demise of thehaulage industry. In response, Gordon Brown,Britain's prime minister, is badgering oilbosses to increase production from the NorthSea, while Nicolas Sarkozy, the president ofFrance, wants the European Union to suspendtaxes on fuel.

In America, too, politicians are haranguingoil bosses and calling for tax cuts. Congresshas approved a bill to prevent the governmentfrom adding to America's strategic stocks ofoil, and is contemplating another to enableAmerican prosecutors to sue the governmentsof the Organisation of the PetroleumExporting Countries (OPEC) for marketmanipulation.

But the most popular scapegoats are“speculators” of the more traditional sort.OPEC itself routinely blames them for highprices. The government of India is so surethat speculation makes commodities dearerthat it has banned the trading of futurescontracts for some of them (although not

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oil). Germany's Social Democratic Partyproposes an international ban on borrowing tobuy oil futures, on the same grounds. JoeLieberman, chairman of the Senate's HomelandSecurity Committee, is also mullingregulation of some sort, having concludedthat “speculators are responsible for a bigpart of the commodity price increases”. Theassumption underlying such ideas is that abubble is forming, and that if it werepopped, the price of oil would be much lower.Others assume the reverse: that the price isbound to keep rising indefinitely, sincesupplies of oil are running short. Themajority of the world's crude, according tobelievers in “peak oil”, has been discoveredand is already being exploited. At any rate,the size of new fields is diminishing. Soproduction will soon reach a pinnacle, if ithas not done so already, and then quicklydecline, no matter what governments do.As different as these theories are, theyshare a conviction that something has gonebadly wrong with the market for oil. Highprices are seen as proof of some sort ofbreakdown. Yet the evidence suggests that, tothe contrary, the rising price is beginningto curb demand and increase supply, just asthe textbooks say it should.Stocks, bonds and barrels

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Those who see speculators as the culpritspoint to the emergence of oil and othercommodities as a popular asset class,alongside stocks, bonds and property. Evermore investors are piling into the oilmarkets, the argument runs, pushing up theprice as they do so. The number oftransactions involving oil futures on the NewYork Mercantile Exchange (NYMEX), the biggestmarket for oil, has almost tripled since2004. That neatly mirrors a tripling of theprice of oil over the same period.But Jeffrey Harris, the chief economist ofthe Commodity Futures Trading Commission(CFTC), which regulates NYMEX and otherAmerican commodities exchanges, does not seeany evidence that the growth of speculationin oil has caused the price to rise. Risingprices, after all, might have beenstimulating the growing investment, ratherthan the other way around. There is no clearcorrelation between increased speculation andhigher prices in commodities markets ingeneral. Despite a continuing flow ofinvestment in nickel, for example, its pricehas fallen by half over the past year.By the same token, the prices of severalcommodities that are not traded on anyexchange, and are therefore much harder forspeculators to invest in, have risen evenfaster than that of oil. Deutsche Bank

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calculates that cadmium, a rare metal, hasappreciated twice as much as oil since 2001,for example, and the price of rice has risenfractionally more.Investment can flood into the oil marketwithout driving up prices because speculatorsare not buying any actual crude. Instead,they buy contracts for future delivery. Whenthose contracts mature, they either settlethem with a cash payment or sell them on togenuine consumers. Either way, no oil ishoarded or somehow kept off the market. Thecontracts are really a bet about which waythe price will go and the number of bets doesnot affect the amount of oil available. As MrHarris puts it, there is no limit to thenumber of “paper barrels” that can be boughtand sold.That makes it harder for a bubble to developin oil than in the shares of internet firms,say, or in housing, where the supply of theasset is finite. Ultimately, says DavidKirsch of PFC Energy, a consultancy, there isonly one type of customer for crude:refineries. If speculators on the futuresmarkets get carried away, pushing prices sohigh that refineries run at a loss, they willsimply shut down, causing the price to fallagain. Moreover, speculators do not alwaysassume that prices will rise. As recently as

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last year, the speculative bears on NYMEXoutweighed the bulls.There is, admittedly, a growing category ofinherently bullish investment funds that seekto track commodity-price indices, in whichoil is usually the biggest component.Politicians have begun to denounce these“index funds”, since they make money fortheir investors only if prices rise.According to Mr Lieberman, they have grown invalue from $13 billion to $260 billion overthe past five years. This surge of investorsbetting on rising prices, many observerscontend, has become a self-fulfillingprophecy, helping to push prices ever higherand thus attract yet more investment.But Bob Greer, of PIMCO, an asset-managementfirm, argues that even index funds makeunlikely suspects. For one thing, they tooinvest in futures, rather than in physicalsupplies of oil. So every month, they musttrade contracts that are about to fall duefor ones that will not mature for severalmonths. That makes them big sellers of oilfor prompt delivery.What is more, their growth is not asimpressive as it first appears. Paul Horsnellof Barclays Capital, an investment bank, putsthe total value of index funds and othersimilar investments at $225 billion. That isless than half the market capitalisation of

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Exxon Mobil, he points out, and a tinyfraction of the $50 trillion-odd oftransactions in the oil markets each year.Although index funds have grown quickly, thatgrowth stems in large part from the rise invalue of the futures they hold, rather thanfrom fresh investment flows. He estimatesthat index funds swelled by $13 billion inthe first quarter of this year, for example,of which all but $2 billion derives from therise in commodity prices.

Back to basics

Mr Harris of the CFTC, for one, believes thatthe oil price is still a function of supplyand demand. For the past few years, theworld's production capacity has grown onlysluggishly. Meanwhile, demand, especiallyfrom the developing world, has been growingfaster. So there is hardly any slack in thesystem. Only Saudi Arabia and the United ArabEmirates are thought to be able to increasetheir output from today's levels, and eventhen, there are doubts, since Saudi Arabia,in particular, is secretive about the stateof its oil industry.That leaves the oil market at the mercy ofeven small disruptions to supply. Prices tendto jump each time militants sabotage an oilpipeline in Nigeria, bad weather threatens

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production in the Gulf of Mexico, orpolitical clouds gather over the PersianGulf.The problem is exacerbated by a growingmismatch between the type of oil beingproduced and the refineries that must processit. The most common benchmark prices,including the one used in this article, referto “light” crude, the least viscous sort,which produces the most petrol and dieselwhen refined. “Heavy” oil, by contrast,yields more fuel oil, which is used mainlyfor heating.At the moment, diesel is in short supply andthere is a glut of fuel oil. That makesprocessing heavy oil unprofitable for somerefineries, since the gains from diesel areoutweighed by losses on fuel oil. Asrefineries turn instead to lighter grades, itpushes their prices yet higher. The discounton heavier crudes has risen to record levels.But even then, points out Ed Morse, of LehmanBrothers, another investment bank, Iran ishaving trouble selling the stuff. It isstoring huge quantities of unsold oil ontankers moored off its coast.

Presumably, Iran and other heavy-oilproducers will eventually be obliged to dropprices far enough to make processing thestuff worth refiners' while. In the longer

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run, more refineries will invest in theequipment needed to crack more diesel out ofheavy oil. Both steps will, in effect,increase the world's oil supply, and so helpto ease prices.

But improving an existing refinery orbuilding a new one is a slow and capital-intensive business. Firms tend to be veryconservative in their investments, sincerefineries have decades-long life-spans,during which prices and profits can fluctuatewildly. It can also be difficult to find asite and obtain the right permits—one of thereasons why no new refineries have been builtin America for over 30 years. Worse, new kitis becoming ever more expensive. CambridgeEnergy Research Associates (CERA), aconsultancy, calculates that capital costsfor refineries and petrochemical plants haverisen by 76% since 2000.

Much the same applies to the development ofnew oilfields. CERA reckons that the cost ofdeveloping them has risen even faster—by110%. At the same time, oilmen remain scarredby the rapid expansion of output in the late1970s, in response to previous spikes inprices, that led to a glut and so to aprolonged slump. Exxon Mobil claims that itstill assesses the profitability of potential

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investments using the same assumptions aboutthe long-term oil price as it did at thebeginning of the decade, for fear that pricesmight tumble again. Environmental concernsare also an obstacle: America, for one, hasbanned oil production off most of itscoastline.Increasing nationalism on the part of oil-rich countries is adding to the difficulties.Geologists are convinced that there is stilla lot of oil to be discovered in the MiddleEast and the former Soviet Union, butgovernments in both regions are reluctant togive outsiders access. Elsewhere, the mostpromising areas for exploration are also themost technically challenging: in deep water,or in the Arctic, or both. Although therehave been big recent discoveries in suchplaces, they will take longer to develop, andcosts will be higher. The most expensiveprojects of all involve the extraction of oilfrom bitumen, shale and even coal, throughelaborate processing. The potential for theseis more or less unlimited, although analystsput the costs as high as $70 a barrel—morethan the oil price this time last year.Nonetheless, PFC Energy has examined projectsthat are already under way, and concludedthat global oil production will grow by over3m barrels a day (b/d) over the course ofthis year and next. In particular, it expects

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production outside OPEC to grow by about500,000 b/d both years—a marked increase fromthe near stagnation of recent years.

Meanwhile, the high price is clearlybeginning to crimp demand. The growth inglobal consumption last year was barely aquarter what it was in 2004 (see chart); thisyear, it is likely be even lower. In richcountries (or at least among the members ofthe Organisation for Economic Co-operationand Development (OECD), a rough proxy), theeffect is even more pronounced. Consumptionhas been falling for the past two and a halfyears.Poorer countries' demand for oil is stillrising, albeit at a slowing pace. That ispartly because their economies are growingfaster, and partly because their consumersare shielded from the rising price throughsubsidies. But the increasing expense of suchmeasures is forcing governments to water themdown or scrap them altogether. That, in turn,should further sap consumption.

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Oil pique

China's growing thirst for oil is often putforward as one of the main factors behindtoday's higher oil prices. Demand for dieselthere, for example, rose by over 9% in theyear to April. But Mr Morse argues that suchgrowth might not last. The government hasordered oil firms to increase their stocks offuel by 50% to be sure there are noembarrassing shortages during the Olympics.It is also planning to run some power plantsnear Beijing on diesel rather than coal, inan attempt to reduce pollution during thegames. These measures are helping to boostChina's demand for diesel, but the effectwill be transitory.In the short run, neither demand for norsupply of oil is very elastic. It takes timefor people to replace their old guzzlers withmore fuel-efficient cars, or to switch tojobs with shorter commutes, or to move closerto public transport. By the same token, itcan take ten years or more to develop anoilfield after its discovery—and that doesnot include the time firms need to bolstertheir exploration units. Gary Becker, an economist at the Universityof Chicago, has calculated that in the past,over periods of less than five years, oilconsumption in the OECD dropped by only 2-9%

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when the price doubled. Likewise, oilproduction in countries outside OPEC grew byonly 4% every time the price doubled. Butover longer periods, consumption dropped by60% and supply rose by 35%. The precisenumbers may be slightly different this timeround, but the pattern will be the same.

Questions1. Mr Harris of the CFTC, for one,

believes that the oil price is still afunction of supply and demand. Do youagree? Explain.

2. Do a brief yet incisive analysis ofpetroleum prices in India.

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