Economics has only four basic principles: marginality, elasticity, substitution and time preference. And as anyone who ever completed a basic course can attest, prices are set at the margin. It is the price offered for the last unit produced and the cost of producing the last unit that really matter. These principles from the so-called dismal science paradoxically give us reason to be optimistic about the world's energy picture. As I never tire of pointing out, usually to the consternation of the hot-commodities crowd, long-term constant-dollar prices for commodities must decline for reasons of substitution and the price elasticity of demand. As price rises, additional substitutes become economic and demand for the marginal unit declines. Of course, we are dealing with a set of two-edged swords here. The very same roster of energy alternatives bandied about today were bandied about in the 1970s: solar, wind, oil sands, oil shale, heavy oil, coal gasification and/or liquefaction, liquefied natural gas, coal seam gas, Devonian shale, tight sands gas, tidal and so on. Why are these sources still called alternative? The marginal unit of conventional fossil fuels remained cheaper and more abundant than any of them and therefore the alternatives remained uneconomic. Billions of dollars were wasted on those alternative energy projects by both private firms and governments until the 1985-86 oil-price collapse brought the farce to an end. As I emphasized last March , everyone running an energy business today is a survivor of that collapse, and as Mark Twain observed, a cat that sits on a hot stove will not sit on a hot stove again. Or a cold one.
Here Comes the Sun
I participated in a conference on alternative energy sources in 1981 in which an investment banker was touting the use of wood as a renewable energy source. His marketing gimmick was ingenious; he kept referring to wood as "young coal," and the truth of that moniker was and is indisputable. With the sole and prominent exception of nuclear, all energy sources can be traced back to the sun, either in the form of current thermal gradients (wind, hydroelectric) or in the form of fossil fuels, solar energy captured by plants and converted chemically. A comedian with the marketing moxie of my friend above could call crude oil and natural gas biofuels and be perfectly within his rights.