Can oil be too cheap?

Since yesterday, the price of a barrel of oil has hovered around $70, representing a greater than 50% drop since the highs of July. This should, by itself, induce a fair amount of enthusiasm from American consumers and businesses, as the high price of petroleum products, chiefly gasoline, was beginning to exert a significant drag on the US economy. For most Americans, the question posed in the title of this post is rather absurd, and even if one might answer in the affirmative, they would argue that we are far from that point. After all, it was just five years ago that the nominal price of a barrel of oil was under $30.

But one area of great importance will be adversely affected by lower crude: alternative energy. Both US presidential candidates have talked up the need for heavy public and private investment in alternative energy sources, but the bulk of the campaign has taken place amid historically high oil prices. It is hardly provocative to support such investment when oil is traded at $140 per barrel and a gallon of gas approaches $5.

But at the end of the day, there is a point at which alternative energy – despite recent technological innovations – simply is not economically viable. Many economists and businesspeople feel that point is around $70/barrel for oil.

Should oil drop beneath that point for a sustained amount of time, it is possible that history will repeat itself, and the nascent alternative energy industry will collapse. This same pattern occurred in the late 1970s and early 1980s. Between 1980 and 1988, the inflation-adjusted price of oil fell by more than 72%. That combined with drastic cuts to alternative-energy subsidies and research throughout the Reagan administration created a doomsday for alternative energy.

The bottom line is that, if we are ever going to wean ourselves off of foreign oil (and, at this point, that means just oil…period), sustained public investment (read here: subsidies) in alternative energy over the long term is needed. I am typically not a fan of subsidizing anything, but this is a unique issue that bears directly on (a) meeting our future energy needs; (b) correcting our trade and budget imbalances; (c) and managing our military and defense commitments around the world. In short, alternative energy is the key to our long-term energy, fiscal, and defense strategy – no other single issue affects our long-term future with quite the same degree of magnitude.

We, then, need to view alternative energy investment not so much as an industry subsidy, but as a monumental public project.

An interesting question was put to the presidential candidates in a recent debate, which asked them how they viewed the alternative energy challenge: should we view it as similar to the race for the atomic bomb, requiring a massive federal effort (The Manhattan Project), or should it be left to the market (the rise of high technology via Silicon Valley).

It’s a clever question, but not quite on point. The way the question is asked needlessly pits free-market ultra-capitalists against the advocates of big government. But there is room here for both approaches. Indeed, many major American industries have thrived with a mixed approach to innovation, notably automobile manufacturing and pharmaceuticals, and given the smaller and smaller role that corporate America plays in basic research, government-sponsored approaches to alternative energy is probably a must at this point.

In any event, our push toward alternative energy sources cannot be held hostage by the cyclical rise and fall of oil prices, and if the current drop in oil is sustained, thereby making private-sector attempts at innovation uneconomical, it will test the next administration’s devotion to alternative energy.