Replacing Oil: Alternative Fuels and Technologies

Replacing Oil: Alternative Fuels and Technologies
Fall 2006 Issue Number 163 -- By Raymond J. Kopp, Resources for the Future

Most experts look to alternative fuels and technologies as promising complements to petroleum in the near term and likely substitutes in the long term. Currently, 98 percent of the U.S. transport sector runs on petroleum. The reasons for this dominance are simple. Transportation fuels derived from petroleum pack a lot of energy in a small volume and weight. The internal combustion engine (ICE) found in practically every vehicle is compact, powerful, and well suited to transportation applications. And until recently, petroleum has been a bargain, at least in the United States. If alternative energy sources are to compete effectively with petroleum, they must be price competitive, perform well with existing ICE technology, or be packaged with a new motor entirely, probably an electric one.

The extent to which alternative fuels can reduce U.S. dependence on petroleum, lessen the impact on U.S. consumers of spikes in the world price of petroleum, and improve U.S. national security through reductions in imported petroleum depends on the scale of their penetration into the transport fuel market. Penetration in turn depends on the cost of delivered alternatives in relation to gasoline and diesel, the degree to which these alternatives are viewed as viable substitutes by consumers, the availability of vehicles designed to utilize the fuels, and the necessary fuel distribution infrastructure.

The advantages enjoyed by petroleum divide the potential competitors into two camps-liquid biofuels (ethanol and biodiesel) that can be used in ICEs and other energy sources, such as hydrogen and electricity, that require new motor technologies. In the case of hydrogen, a radically new delivery infrastructure is also needed. In the near-to-medium term, biofuels are poised to be competitive. In the longer term, hydrogen and electricity offer the technical potential to completely wean the United States from petroleum use.

BIOFUELS OVER THE NEXT 5-10 YEARS
Biofuels seem well positioned to penetrate the transportation market. Ethanol can be produced from corn, sugar, and fibrous plants, such as switchgrass. Currently, 10 percent ethanol is blended with gasoline to make e10, in large part as a substitute for MBTE (once added to gasoline for environmental purposes). However, with limited vehicle modifications costing between $50 and $150 per vehicle, new vehicles can be produced to run on as much as 85 percent ethanol (e85) as well as 100 percent gasoline. These "flexfuel" vehicles are currently being produced by U.S. automakers; General Motors, for example, estimates that more than two million of its flex-fuel vehicles are on the road in the United States today.

A government subsidy of 51 cents per gallon already makes corn-based ethanol price competitive in the United States with gasoline in the neighborhood of $3.00 per gallon. However, the relatively small quantity of ethanol produced is predominately used in e10 blends.

If e85 becomes popular, production must be scaled up, which may raise the cost as demand rises. Further, ethanol has about 70 percent of the energy content of gasoline, which equates to fewer miles per gallon. Therefore, if gasoline sells for $3.00 per gallon, competitive e85 must sell for no more than $2.20 to attract consumers.

The Renewable Fuels Association lists 102 ethanol refineries currently operating in the United States, with an additional 43 refineries and seven expansions under construction. However, U.S. production of ethanol from corn is limited by the availability of agricultural land suited to corn production and competing food demand for corn.

Outside the United States, ethanol has been made for many years from sugar; in Brazil, for example, ethanol from sugar accounts for about 20 percent of the transport fuel market. Indeed, the World Bank believes Brazil can make ethanol from sugar for about $1 per gallon. Unfortunately, imports of ethanol from Brazil face high tariffs, a 2.5 percent tax on the value, and a secondary tariff of 54 cents per gallon, imposed to roughly offset the 51-cents-per-gallon domestic subsidy. Reducing or eliminating these tariffs might expand ethanol supply to the United States, thereby lowering cost and accelerating the penetration of this fuel into the U.S. transportation fuel market.

Ethanol can also be produced from woody fibrous plants, such as switchgrass. The use of a low-cost and readily available feedstock has led many to believe that cellulosic ethanol could be very price competitive with gasoline in the future after the production technology has evolved somewhat further. Honda Motor Company recently reported successes using strains of microorganisms developed in Japan to more efficiently convert the sugar in cellulose into alcohol. And unlike corn, biomass for cellulosic conversion need not consume prime agricultural land and, as a result, may be grown in larger quantities.

The Department of Energy forecasts total ethanol production from corn and cellulose to be 10-14 billion gallons annually by 2030. While this would amount to 30 percent of worldwide ethanol production, it is still less than 10 percent of projected U.S. gasoline demand. The president's Advanced Energy Initiative, announced in his 2006 State of the Union speech, will increase research funding for cellulosic ethanol, with the goal of making it cost-competitive with corn-based ethanol by 2012.

Production of biodiesel made from recycled cooking oil (called yellow grease) or raw vegetable oils from crops such as soybeans was developed as early as the invention of the diesel engine in 1878. Like ethanol production, biodiesel enjoys government subsidies that make it price competitive with petroleum. The Energy Information Administration estimated the current cost of a gallon of biodiesel made from vegetable oil to be $2.49 and the cost from yellow grease to be $1.39 in 2002 dollars. In comparison, EIA estimated the cost of diesel from petroleum to be 78 cents a gallon. To compete, biodiesel received a production subsidy from the Commodity Credit Corporation during fiscal years 2004-2006 of $1.45-$1.47 per gallon if made from soybean oil and 89-91 cents per gallon if made from yellow grease.

On top of this production subsidy rests a tax credit for blenders who add biodiesel to petroleum diesel. The blenders receive a credit against the federal excise tax they pay of approximately $1.00 per gallon for vegetable oil-based diesel and 50 cents per gallon for yellow grease. These subsidies and tax credits bring the production cost of biodiesel very close to that of petroleum-based diesel.

Biofuels not only substitute for petroleum but they also can have beneficial impacts on climate change. Ethanol and biodiesel are produced within a relatively closed carbon cycle where carbon dioxide (CO2) released into the atmosphere during combustion is recaptured by the plant material and used to produce additional fuels. To the extent these biofuels displace petroleum, they reduce CO2 emissions and therefore are more climate-friendly than petroleum.

However, crops must be cultivated to provide the needed feedstock and then processed to produce the fuels. Cultivation and processing involve the use of energy and other inputs, such as fertilizer, that can have negative effects on greenhouse gas emissions and other environmental impacts, like water pollution. A full production-cycle analysis is needed to make definitive statements regarding the positive climate impacts of large-scale biofuel production. Careful studies put the "well-to-wheels" greenhouse gas benefits of corn ethanol at about a 20-percent reduction and cellulosic ethanol at about an 80-percent reduction relative to gas derived from conventional oil.

CARBON-FREE CARS
To some, transportation nirvana involves not ICEs, but electric cars running on storage batteries or electricity generated from on-board, hydrogen-powered fuel cells. If ICEs have a role in this utopia, it is in the form of plug-in hybrids-electric cars with sizable on-board battery storage and ICEs to either recharge the batteries or, when needed, provide power directly to the wheels. In either case, the extent to which these alternatives affect our reliance on petroleum again depends on their relative cost with respect to petroleum and biofuels and their acceptability in eyes of the consumers.

Battery-powered pure electric (as opposed to plug-in hybrids) and fuel cell-powered electric vehicles cannot, at present, compete on price and attributes with ICE-powered vehicles. Battery-powered vehicles are much closer to commercial production than fuel-cell vehicles, but as yet none of the major manufacturers have committed to large-scale production (although some small-scale production by start-up companies is expected).

If the goal is to reduce U.S. petroleum consumption over the next decade or two, battery-powered electric vehicles may play a role, but the size of that role depends, as it has in the past, on advances in battery technology. Fuel-cell vehicles must overcome larger engineering problems, including hydrogen storage and development of a safe hydrogen-delivery infrastructure, before they are ready for any widespread commercial deployment.

The bridge between internal combustion engines and an automotive future that doesn't rely solely on petroleum might be the plug-in hybrid that uses grid-charged batteries for short trips (of 50 miles or less). However, the plug-in hybrid still faces the same battery issues that have plagued electric- car development, namely weight, range, and cost. The New York Times reports that Toyota has a plug-in hybrid ready for the market-only time will tell.

STICKS AND CARROTS
Government policy is often a combination of sticks and carrots (mandates and incentives), and this is true for biofuels and advanced vehicles. With respect to advanced vehicles, sticks (mandates) applied to vehicle manufacturers come in the form of regulations like the California Zero Emission Vehicle (ZEV) mandate, which directed automakers to produce specific quantities of electric cars starting in 2003 but has been modified over the years due to litigation. Carrots (incentives) come in the form of tax credits to consumers. For example, tax credits ranging from $400 to $3,400 were available for purchasers of all new hybrid vehicles, but upper limits on government funds available for such credits mean that for certain hybrids (notably the Toyota Prius) funds will soon be exhausted. Tax credits up to $4,000 are still available for purchasers of new pure electric cars that run on batteries or electricity from hydrogen fuel cells. The idea behind both sticks and carrots is to develop a market for these vehicles in the hopes that increased production will lead to lower costs, making these vehicles competitive with ICEs.

Government biofuel policy is also composed of incentives and mandates designed to establish markets and increase domestic production. The most important mandate is the recent renewable-fuel standard contained in the 2005 Energy Policy Act requiring that 2.78 percent of the gasoline sold or dispensed in calendar year 2006 be renewable. There is good reason to believe this target will be met if not exceeded. Incentives are provided through provisions of the 2002 Farm Bill encouraging the production of biofuels through small grant programs, the subsidies provided by the Commodity Credit Corporation (discussed previously), and 2005 Energy Policy Act's provision of additional subsidies to domestic ethanol and biodiesel producers.

One can't know for certain how effective incentives-in the form of purchase subsidies-have been at spurring hybrid, pure electric, and fuel-cell vehicle sales. However, it seems likely that although hybrid sales have benefited from the credits, consumer satisfaction with the vehicles, combined with fear of ever-higher gasoline prices, has been a substantial motivator. Similarly, it is doubtful that continued credits will do much to build consumer demand for pure electric and fuel-cell vehicles until those vehicles meet customer demands and gasoline prices remain high. What is needed is breakthrough battery technology; any government policy that can accelerate the attainment of this goal will have a significant effect on the commercialization and penetration of these vehicles.

Subsidies have no doubt been instrumental in the growth of biofuel production. The issue facing policymakers now is whether these subsidies will be necessary in the future, how they can be set in some optimal sense (that is, as low as possible to achieve the desired result), and how can they be removed or reduced given the political constituency they have developed.

SECOND-BEST ALTERNATIVES
The key rationale for reducing petroleum consumption lies in the fact that the market price does not account for its full social cost: the negative externalities or consequences associated with petroleum use-such as greenhouse gas emissions and national security issues-are not incorporated in the market prices.

For economists, the standard policy response to these externalities is the imposition of a tax equal to the marginal value of the externality so that the market price would represent the full social cost of petroleum consumption. The policies discussed above are second-best alternatives to a tax policy and therefore will be less efficient than a tax (perhaps by a wide margin). Given the lack of political will to impose taxes on petroleum, second best may be all we have at the moment, but that is no reason to cease striving.

Even in a second-best world, some policies are better than others. In the case of biofuels, we are concerned with their continued commercialization, the establishment of a robust market for them, and the growth of delivery infrastructure. In the case of new motor technologies (all electric or fuelcell cars), we are concerned with continued technology development in this pre-commercial phase. Subsidies and mandates are better suited to commercialization, while policies focusing on R&D are better suited pre-commercialization.

In the near future, biofuels will have to stand on their own without the large subsidies they are now enjoying, if only to protect the U.S. Treasury and taxpayers from ballooning subsidy payments. At the very least, the corn-ethanol subsidy should be phased out, as well as the import restrictions.

What's the Big Deal about Oil?

What's the Big Deal about Oil?
Fall 2006 Issue Number 163 -- By Richard G. Newell, Resources for the Future

America's massive transportation network runs almost exclusively on oil--and increasingly the country considers that reality to be a source of vulnerability. Effectively dealing with this problem will require reducing our consumption of oil, especially on the highway. How can we do that without damaging a huge economy that crucially depends on fast, inexpensive movement of people and goods?

We are now being forced to consider this question more seriously than at any time since the age of oil began more than a century ago, for a number of reasons. One is the recent series of disruptive swings, mostly upward, in oil prices. These price swings hurt both household budgets and the larger economy. Another is political instability in oil-exporting regions that, in many cases, involves a U.S. military presence. Importantly, there is also mounting evidence of global climate change caused by burning oil and the other fossil fuels, coal and natural gas.

These concerns were reflected in President Bush's much-quoted line in the 2006 State of the Union Address that "America is addicted to oil." That leads to all the hard questions about how to best address this problem, the role of the market and public policy in efficiently deploying options, and how to balance the search for expanded supplies with policies that can reduce demand. In this special issue of Resources, we put the president's comment in perspective and evaluate various policy options.

WHERE'S THE OIL?
Existing oil reserves are geographically concentrated in some of the world's most volatile regions, in many cases under the control of governments that are unfriendly to U.S. interests. This raises concerns about the possibility of oil supply disruptions due to war, revolution, terrorist attacks, or trade embargoes, as well as the likelihood of continued or increased U.S. military presence abroad. Although the United States contributes 10 percent of global oil production, it has just 2 percent of proven world reserves. In contrast, about 60 percent of proven oil reserves are located in the Middle East, 10 percent in Africa, 6 percent in Venezuela, and 5 percent in Russia. Canadian tar sands are a relative bright spot in this geopolitical picture, comprising about 14 percent of proven oil reserves.

Some analysts have also drawn recent attention to the view that world oil production has peaked. In the past, however, new discoveries and improved technology have continually led to increases in world oil reserves and production along with consumption growth. A case in point is Chevron's announcement in September that it has tapped petroleum reserves in the Gulf of Mexico that could rival Alaska's Prudhoe Bay in size. In the process, it set several records for ultradeep drilling. And while conventional oil production will no doubt peak at some point in time, unconventional and synthetic sources of oil--such as tar sands and coal-to-liquids (CTL)-- are already competitive at or near current price levels and could last for a long time to come.

PUTTING PRICES IN PERSPECTIVE
At press time, the average price of gasoline at the pump was about $2.30 per gallon, down from recent highs above $3 per gallon. Since early 2002, gasoline prices have doubled, along with a tripling of crude oil prices from around $20 per barrel to $60 or more per barrel. Crude oil price changes tend to be quickly passed through to consumers at the rate of about 24 cents per gallon of gasoline, for every $10 per barrel change in the price of crude.

The vast majority of the gasoline price increases over the last several years are therefore attributable to crude oil price increases. Historically tight refining capacity and weather-related disruptions have played secondary roles. Refinery or pipeline shutdowns--such as during Hurricanes Katrina and Rita last year--can impede production and distribution of petroleum products, leading to short-term gasoline price spikes.These concerns were reflected in President Bush's much-quoted line in the 2006 State of the Union Address that "America is addicted to oil." That leads to all the hard questions about how to best address this problem, the role of the market and public policy in efficiently deploying options, and how to balance the search for expanded supplies with policies that can reduce demand. In this special issue of Resources, we put the president's comment in perspective and evaluate various policy options.

IMPLICATIONS FOR THE ECONOMY
The macroeconomic impact of oil price spikes is a distinct concern. Every major oil price increase since 1970, except the current one, has been associated with a recession. This raises worries about inflationary effects, interest rate hikes, increased production costs, slower GDP growth, and potential recession and job losses.

Then there's the fact that the United States imports 60 percent of the petroleum it consumes, about double the share we imported two decades ago. When oil prices spike, we send large additional amounts of wealth overseas to pay for an increasing oil-import bill--over $240 billion in 2005. This has to be balanced, of course, against the fact that U.S. households and businesses benefit greatly from the same imports, particularly when prices are low.

So far, however, the price increases over the last several years have been only a modest drag on economic growth. In contrast to conditions during price shocks of the 1970s and early 1980s, global economic growth has been robust, inflation and interest rates have been historically low, and the oil intensity of the U.S. economy (the ratio of oil consumption to GDP) has declined.

PRICING THE ALTERNATIVES
Although oil prices have risen to more than $70 per barrel in recent months, they have also averaged as low as $20 per barrel within the last five years. Having lived through the oil price spikes--and then dramatic declines--of the 1980s, oil companies typically use an expected oil price of less than $40 per barrel when making long-term investments. Most current forecasts by government and private analysts project oil prices in the $35- $55 per barrel range over the next two decades, whereas the large capital investments associated with many alternatives would last for several decades.

Only conventional oil, tar sands, and gas-to-liquids (GTL-- conversion of natural gas to transport fuel) are clearly profitable at these prices. The federal ethanol subsidy of 51 cents per gallon is equal to about $30 per barrel of oil equivalent (that is, energy equal to one barrel of oil), making ethanol competitive at oil prices as low as $20 per barrel of oil. Given these market signals, largescale commercial production of Canadian tar sands and ethanol has already begun and is expanding rapidly. One million barrels of oil from Canadian tar sands are being produced per day, a rate that is projected to almost triple over the next decade. U.S. ethanol production, virtually all of which comes from corn, has risen from 106,000 to 250,000 barrels per day since 2000. It is expected to roughly double again by the end of the decade at projected oil prices and with current government subsidies.

GTL technology has developed rapidly in recent years, as higher oil prices have made it a more attractive option for "stranded" natural gas reserves that have no local market. Currently, only Malaysia and South Africa have commercial GTL operations, but new projects have been proposed for Algeria, Australia, Egypt, Iran, Nigeria, and Qatar.

Commercial- scale CTL plants have operated in South Africa for several decades. Interest in other countries was limited until recently, but China now has plans to open two CTL plants after 2008 and a number of proposals have been floated in the United States.

For other alternatives, such as oil shale and cellulosic ethanol, costs are uncompetitive even at the high prices recently experienced. The technologies needed for production require further research, development, and demonstration to bring down costs and establish commercial viability. Cellulosic ethanol is made from grasses, agricultural waste, and other sources of biomass rather than corn, sugar cane, or other higher-value agricultural feedstocks. Interest in cellulosic ethanol has increased considerably, and the federal renewable fuel standard passed in the Energy Policy Act of 2005 ensures that at least some commercial cellulosic ethanol will be produced in the next several years.

DEALING WITH THE ENVIRONMENTAL CONSEQUENCES
While recent congressional debates have focused on the potential benefits and environmental risks of expanding access for drilling in the Outer Continental Shelf and Arctic National Wildlife Refuge, the larger environmental issue looming is global climate change. Rising oil prices present both opportunities and risks from the perspective of reducing greenhouse gas (GHG) emissions, particularly carbon dioxide. The incentive that high oil prices bring for increasing fuel economy and encouraging other sources of demand reduction is a clear winner for the climate.

Renewable fuels like ethanol can also lead to moderate or more dramatic reductions in GHG emissions, depending on the feedstock. Although corn-based ethanol offers significant gains in terms of reducing petroleum use, it offers only moderate climate benefits. GHGs from corn-ethanol production and use are only about 20 percent lower than for gasoline because of the need to use fossil fuels like natural gas in the process of growing and processing the corn. More importantly, cellulosic ethanol has the potential to reduce GHG emissions by about 80 percent relative to gasoline.

On the other hand, the most economically competitive, large-scale substitutes for conventional oil are currently not renewable fuels, but tar sands and CTL. Shale oil is currently expensive to produce, but the resource base is large, and costs could come down considerably. Reasonable estimates put GHG emissions associated with the production and use of tar sands at about 25 percent higher, oil shale at about 65 percent higher, and CTL at about 75 percent higher than conventional oil. These higher levels of GHG emissions are due to greater emissions during the production process, whereas GHG emissions from end-use combustion of these fuels are roughly the same.

AN ECONOMIC PERSPECTIVE ON OIL POLICY
Economists have identified a number of problems related to oil production and use that may not be adequately incorporated in private market decisions in the absence of government policy. These include the macroeconomic impacts of oil price shocks, local environmental and global climate-related effects, and national security consequences associated with constrained foreign policy and military burdens.

Policy responses tend to fall into two broad classes: supplyside and demand-side approaches. Supply-side policy approaches typically focus on expanding domestic production of crude oil and its alternatives (such as ethanol and CTL). Demand-side approaches focus instead on reducing petroleum consumption through increased fuel economy, reduced driving, alternative modes of transportation, and non-transport conservation. The Strategic Petroleum Reserve serves a unique role, by holding public stocks of oil for potential release to mitigate price shocks due to severe supply disruptions.

SUPPLY-SIDE OPTIONS
Increased access for domestic oil development is potentially justified based purely on traditional economic grounds--if the value of the oil is greater than the production and environmental costs. However, increased domestic supply does little to decrease our vulnerability to oil price shocks or associated national security threats. Since oil prices are determined in a global market, U.S. prices will rise by the same amount in the event of a disruption regardless of whether they are for domestic or foreign barrels. And money will flow to unfriendly regimes even if it is not U.S. dollars. Iran is a useful reminder: the United States has banned oil imports from Iran since 1979, but that does not reduce Iran's oil wealth or the sway it holds over oil prices.

Policies oriented toward increasing the supply of alternative fuels through subsidies or mandates, such as ethanol and other liquid fuels, do little to reduce our vulnerability to price shocks. They are direct substitutes for oil and have relatively high production costs. In the event of an oil price shock, the price for fuel will therefore be determined largely by the international price of crude oil, not domestic fuel production costs. Only a dramatic shift to an alternative energy source that is not in direct competition with oil (for example, electricity or hydrogen) could remove this strong linkage. One way in which supply-side options can help, however, is by increasing the diversity of fuel supply types and locations. As described earlier, the environmental impacts of expanding domestic alternatives to conventional oil could be either positive or negative, depending on the fuel type.

DEMAND-SIDE OPTIONS
In contrast, policies that encourage demand-side reductions in fuel consumption are better targeted at addressing all the major concerns related to oil production and use. With lower fuel use, households and businesses are affected less by oil price shocks, and other negative macroeconomic consequences are reduced, as are local environmental effects and GHG emissions. Two categories of relatively cost-effective policies are most often discussed: policies that directly or indirectly raise fuel prices, and policies that raise vehicle fuel economy. The first category includes taxes on gasoline or petroleum, as well as policies that put a price on GHG emissions, such as a cap-and- trade system or carbon tax. Each of these provides a direct monetary incentive to reduce petroleum consumption, although the breadth of a petroleum tax or a price on GHG emissions is much greater than a tax solely on gasoline.

Fuel economy policies, the second category, can take the form of either performance standards--as with Corporate Average Fuel Economy (CAFE) standards--or purchasing incentives, such as "feebates" that combine fees on inefficient vehicles with rebates for efficient ones. Each can be designed in a flexible, cost-effective manner or can be riddled with constraints and loopholes that render it ineffective and inefficient. Relative to policies that raise fuel prices, however, fuel economy policies have the disadvantage of not encouraging demand reduction through reduced driving.

CONCLUSION
The key to more effective policy on oil and its alternatives lies in correctly deciding which part of the oil "problem" to solve. Policymakers often look no further than high gasoline prices and oil imports, an orientation that leads to "solutions," such as repealing the federal gasoline tax and expanding wasteful government subsidies for domestic energy production. These approaches can actually hurt rather than help.

The top priorities for oil policy should instead be reducing both our vulnerability to supply disruptions and GHG emissions. The emphasis would then turn to reducing our exposure to these risks through reduced fuel consumption, diversifying our options through research and development of low-emission alternative fuels and technologies, and insuring against disruptions through wise use of the Strategic Petroleum Reserve.

Proposals have been floated to target virtually all of the options laid out in this special issue of Resources, but few have passed Congress or reached the president's desk. When that day comes, decisions should be guided by reason, not rhetoric: our economic and environmental future is at stake.

Benefits of Pay-As-You-Drive Insurance

The Advantages of Pay-As-You-Drive Insurance
November 30, 2006 -- Economist's View Blog

In a recent Economic Scene article for The New York Times posted here, Hal Varian explains the benefits of per-mile auto insurance.

In the article, Hal Varian discusses work by Aaron S. Edlin and Pinar Karaca-Mandic from their paper, “The Accident Cost From Driving.” In this article from Economist's Voice, Aaron Edlin summarizes work in this area with a focus on the political advantages of using per-mile auto insurance to reduce gasoline consumption

If Voters Won’t Go for Taxing Oil to Conserve Energy, How Do We Do It?, by Aaron S. Edlin, Economist's Voice, November, 2006: ...Lowering our dependence on oil would give the United States considerably more flexibility in Middle East policy. It would also help us to fight global climate change. Yet precious little has been done. The obvious solution of European-size taxes on gasoline and other uses of oil is just too unpopular in the United States to become law. ...

What can be done to decrease America’s energy dependence, given the public’s apparently well entrenched fear of increases in the cost of driving? One way forward may be a simple reform to auto insurance: Pay as You Drive.

Pay-as-you drive-insurance: how it would work

Currently, auto insurance is largely, but not entirely, independent of the amount of driving a person does. If an individual drives 5,000 miles per year, instead of 25,000, then her insurance rate is reduced only slightly: often, by 15% or less. ...

Suppose that, instead, ... that auto insurers were required to quote premiums on a per-mile driven basis instead of a per-year basis.

Consider a given class of drivers ... whom insurance companies currently charge $1000 per year, and who currently drive 10,000 miles per year on average. Instead of charging these drivers $1000 per year, insurers might charge 10 cents per mile driven.

The average driver ... would continue to pay the same amount—$1000 per year— assuming no change in driving behavior. However, suppose this driver chooses to cut her driving in half, to 5,000 miles per year... Then she would save $500/year, much more than under the current pricing system. Moreover, if the same driver were to double her driving, she would double her insurance cost... Such a pricing system would give her a significant incentive to reduce her driving. Elsewhere, I have estimated that such pay-as-you-drive insurance could reduce driving and gasoline consumption by 10–15%.

The political advantage of pay-as-you-drive insurance over a gas tax is that it doesn’t increase the total cost of driving, at least on average. ... Prices at the pump, of course, stay the same—making the measure much more palatable... And rather than voters simply fearing negative consequences, they can enjoy some positive ones: lowered insurance prices as a reward for changes in behavior. ...

The change won’t be painless for everyone, of course. Those who drive twice the average will pay twice as much. But that’s only fair: They also cause more accidents, and burden the environment, and worsen our dependence issue, twice as much. And charging high mileage drivers more is exactly what will give people an incentive to drive less.

The peculiar all-you-can-drive way that auto insurance is currently priced

The late Nobel Laureate William Vickrey wrote almost forty years ago that “the manner in which [auto insurance] premiums are computed and paid fails miserably to bring home to the automobile user the costs he imposes in a manner that will appropriately influence his decisions.”

The costs to which Vickrey referred were accident costs, not terrorism, climate, and national security costs. The great thing, though, is that by switching our insurance system to pay-as-you-drive insurance, we can reduce accident costs with more efficient accident pricing, and reduce these other costs as a bonus. ...

Vickrey’s point is that with each mile we drive, there is a cost in the form of accident risk. When we don’t pay the costs we impose, the incentives are obvious: we drive more than is economically efficient, causing accidents as we go. If we paid as we drove, and were charged a per-mile premium we would choose to drive less and there would be fewer accidents. And that would be fair: we would simply be forced to pay for the externalities of our conduct. ...

If Americans are successfully incentivized to drive less by pay-as-you-drive insurance, [accident] costs will fall appreciably... Several insurance carriers have begun to experiment with pay as you drive insurance, but they have not rushed to charge per-mile premiums on their own. Too many of the gains would not be captured by the company changing the policies. They need some encouragement.

The political salability of mandating pay-as-you-drive

...Per-mile premiums ... could lower the cost of driving for most people because most people drive less than the average. (Because driving quantities follow a skewed distribution, the median is considerably lower than the mean). Moreover, such premiums give drivers additional control over their costs, so they can choose to lower them still further.

There would, of course, be opposition. Although more than 50% of people drive less than the arithmetic average, many obviously drive more ... and would tend to oppose the change, at least if they vote their pocket books. Moreover, oil companies, the highway lobby and gas stations can be expected to oppose any change that leads to less driving. ...

[A] full-scale national shift to pay-as-you-drive insurance is too much to hope for. Still, a shift could be made in stages: if each insurance carrier had to issue 5% of its policies at per-mile rates, no carrier would be at a competitive disadvantage. ...

There are many pieces to a sound national energy policy, but per-mile premiums should be high on the list. What is needed is a jump start.

Zoo Poisons Rare Lion Cubs To Sell Corpse For $170

Ethiopian zoo poisons rare lions to cut costs, official says
November 22, 2006 -- AP via CNN

ADDIS ABABA, Ethiopia (AP) -- A major zoo in Ethiopia is poisoning rare lion cubs and selling the corpses to be stuffed because it can't afford to care for the animals, which are the national symbol, the zoo's administrator said Wednesday.

"These animals are the pride of our country," Muhedin Abdulaziz of the Lion Zoo told The Associated Press. "But our only alternative right now is to send them to the taxidermist."

Ethiopia's lions, famous for their black manes, adorn statues and the local currency. The country's emperors were long fascinated by lions, part of their connection with Solomon, the lion of Judah.

Wildlife experts estimate that only 1,000 Ethiopian lions, which are smaller than other lions, remain in the wild.

The Lion Zoo has poisoned six cubs so far this year, Abdulaziz said. He added that the poisoning has been going on at least since he arrived two years ago; the total number of cubs killed was not clear.

Federal wildlife officials monitor the poisoning, which is painless, according to Abdulaziz. The federal officials did not immediately return calls for comment.

The Lion Zoo is a popular attraction in Ethiopia, although international wildlife organizations have expressed concern about its ramshackle facilities. Built in 1948 by Emperor Haile Selassie, it houses 16 adult lions and five cubs in cages surrounded by barbed wire.

The dead cubs are sold to taxidermists for $170 in U.S. money (130 euro), each to be stuffed and resold, Abdulaziz said. Hunters also kill the wild animals for their skins, which can fetch $1,000 (780 euro).

"I feel so sorry about this," said Girma Chifra, 25, who was visiting the zoo Wednesday. "They're a symbol of our country. I didn't know they were killing the cubs, this is not good."

The zoo costs around $6,000 (4,700 euro) to run each month, but it only receives $5,000 (3,900 euro) in revenues from entrance fees, Abdulaziz said.

Mesganu Arga, head of the Information and Culture Bureau in Addis Ababa, said the city was looking into the matter.

"These are rare animals and a treasure to the country," Mesganu said. "We are promoting these lions."

Animal conservation groups expressed outrage at the killings.

James Isiche, regional director of the International Fund for Animal Welfare in Nairobi, Kenya, said the zoo should prevent the animals from breeding if it can't care for them.

"Enforcement to protect these animals is critical," he said.

The Born Free Foundation called for an investigation into the animals' treatment.

"We would encourage the authorities to take action to establish, at the very least, a sanctuary for lions and to enforce whatever laws are necessary to prevent those lions from being unnecessarily killed, sold or given into trade, alive or dead," said Will Travers, chief executive officer of the British-based foundation.

Minimum Wage vs. Earned-Income Tax Credit

A Blunt Instrument
Oct 26th 2006 -- The Economist

A higher minimum wage may not kill many jobs, but won't help many poor people

If the mid-term elections have one central economic issue, it is higher minimum wages. Nancy Pelosi, the leading Democrat in the House of Representatives, has vowed that if her party wins control of that chamber on November 7th, she will introduce legislation to raise the federal minimum wage from $5.15 to $7.25 an hour within her first 100 hours as speaker. In six states, including the swing states of Ohio and Missouri, voters will also decide on whether to raise their state minimum wage. Democrats hope the presence of such initiatives on the ballot will lure their supporters to the polls.

Politically, the strategy makes sense. Americans are hugely in favour of raising minimum wages. In one recent poll 85% of respondents said they supported the idea. Over half said they would be more likely to vote for a candidate if they found out that he supported introducing a rise.

Advocates claim more than politics on their side. They argue that a higher minimum wage also makes economic sense. The Economic Policy Institute (EPI), a left-wing think-tank, recently published a letter signed by over 650 economists, including five Nobel prizewinners, which advocated a rise. Since the federal minimum wage was last raised in 1997 its real value has eroded dramatically. It is now less than in 1951 (see chart). Not only would a modest rise have "very little or no effect" on employment, the letter said, it would be an important tool in fighting poverty.

Strong stuff. But, laureates notwithstanding, it does not reflect a consensus among the dismal scientists. Overall, economists have become less worried about the job-destroying effects of a modest hike in the minimum wage. But most still reckon that it is at best a blunt instrument for fighting poverty.

The academic argument--and there has been plenty of it in recent years--has focused on the employment effects. Elementary economics would suggest that if you raise the cost of employing the lowest-skilled workers by increasing the minimum wage, employers will demand fewer of them. This used to be the consensus view. But a series of studies in the 1990s--including a famous analysis of fast-food restaurants in New Jersey and Pennsylvania by David Card at Berkeley and Alan Krueger of Princeton University--challenged that consensus, finding evidence that employment in fast-food restaurants actually rose after a minimum-wage hike. Other studies though, particularly those by David Neumark of the University of California at Irvine and William Wascher at the Federal Reserve, consistently found the opposite. Today's consensus, insofar as there is one, seems to be that raising minimum wages has minor negative effects at worst. Lawrence Katz, an economist at Harvard University and signatory of the EPI's letter, agrees that "most reasonably well-done estimates show small negative effects on employment among teenagers".

So the academic debate has shifted elsewhere, although the division between sceptics and advocates remains much the same. Mr Neumark, perhaps the leading sceptic about the minimum wage, has published several papers arguing that employers spend less on training their workers as their labour costs rise; that more students drop out of school, lured by fatter pay-packets; and that workers in their late twenties earn less if they were exposed to high minimum wages as teenagers. Other studies, however, do not find this.

Where most economists agree is that the higher minimum wage does not do much to relieve poverty. That is partly because many poor people would not gain (since they do not work); partly because some of the costs of higher minimum wages are shifted onto poor consumers; but mainly because many minimum-wage workers are not poor. Only 5% of the
workforce--some 6.6m people--will gain directly from a rise in the minimum wage, and 30% of those are teenagers, many from families that are not poor. Supporters of an increase, though, argue that once you include the "spillover" effects on workers who earn just above the minimum wage (but whose wages would rise as a result), the income gains from a hike are concentrated among poor families.

Not surprisingly, studies that try directly to measure the distributional consequences reach divergent conclusions. Several studies of the 1990s find that higher minimum wages helped reduce poverty, albeit modestly. Mr Neumark, unsurprisingly perhaps, finds the opposite result. He claims that increased minimum wages actually increased slightly the number of families in poverty (presumably because these workers disproportionately lost their jobs while well-off teenagers got higher wages).

Either way a better tool exists for helping the working poor: the earned-income tax credit (EITC). This tax subsidy, a "negative income tax" that tops up the earnings of the low-paid, was introduced in the 1970s and has been expanded four times since. Its benefits are currently focused on families with children. Single men get little from the EITC. Some left-leaning economists argue that it is important both to raise the minimum wage and expand the EITC. But a big EITC expansion is politically hard (unlike raising the minimum wage, it involves spending taxpayers' money). So others support a higher minimum wage as a second-best solution. If it were up to the economists though, fatter tax subsidies would be top of the list for helping the working poor.

Eco-Economy Update

Eco-Economy Update
November 3, 2006 -- By Lester R. Brown, Earth Policy Institute

EXPLODING U.S. GRAIN DEMAND FOR AUTOMOTIVE FUEL THREATENS WORLD FOOD SECURITY AND POLITICAL STABILITY

Now that the year's grain harvest is safely in the bin, it is time to take stock and look ahead. This year's harvest of 1,967 million tons is falling short of the estimated consumption of 2,040 million tons by some 73 million tons. This shortfall of nearly 4 percent is one of the largest on record.

Even more sobering, in six of the last seven years world grain production has fallen short of use. As a result, world carryover stocks of grain have been drawn down to 57 days of consumption, the lowest level in 34 years. The last time they were this low wheat and rice prices doubled.

The growth in world grain consumption during the six years since 2000 averaged roughly 31 million tons per year. Of this growth, close to 24 million tons were consumed as food or feed. The annual growth in grain used to produce fuel ethanol for cars in the United States alone averaged nearly 7 million tons per year, climbing from 2 million tons in 2001 to 14 million tons in 2006.

Now the amount of grain used to produce fuel is exploding. Investment in crop-based fuel production, once dependent on government subsidies, is now driven by the price of oil. With the current price of ethanol double its cost of production, the conversion of agricultural commodities into fuel for cars has become hugely profitable. In the United States, this means that investment in fuel ethanol distilleries is controlled by the market, not by government.

The huge profits from converting corn into ethanol following the late 2005 oil price hikes have led to a jump in groundbreakings for new ethanol distilleries in the last few months. The World Ethanol and Biofuels reports, published biweekly by F.O. Licht, show construction starting on an astounding 54 new ethanol distilleries in the United States between October 25, 2005, and October 24, 2006. With a typical construction period of 14 months, virtually all of them will be producing by the end of 2007. Together these plants, with 4 billion gallons of annual ethanol production capacity, will consume 39 million tons of grain per year, nearly all of it corn. (See data at http://www.earthpolicy.org/Updates/2006/Update60_data.htm.)

The pace of groundbreakings is accelerating. From November 2005 through June 2006, ground was broken for one new plant every nine days. From July through September 2006, construction starts increased to one every five days. In October 2006, it was one every three days.

Since it typically takes many months for a company to decide to build a distillery, select a site, buy the land, acquire the needed permits, and arrange the financing, the post-Katrina jump in oil prices has only begun to show up in groundbreakings for new plants in the last few months.

To calculate the amount of grain that will be going into ethanol, we start with the 41 million tons of the 2005 crop that were used to produce ethanol and add to that 39 million tons for the new construction starts for a total of 80 million tons of corn. This does not include the additional grain required by the expansion of several existing plants. Nor does it involve the numerous new grain-based ethanol distilleries in other countries, principally those in Europe and China.

Given the recent acceleration in new groundbreakings and the scores of new plants in the planning stages, we could see even more construction starts in the next 12 months. If so, these distilleries could easily absorb an additional 40 million tons of grain.

In looking forward to 2007, how much will we need to increase the harvest to avoid a further drawdown in stocks? First, we need a rise of 73 million tons just to overcome the 2006 production shortfall. Beyond that we will need 24 million tons of additional output to cover the estimated annual growth in food and feed needs. If we then add 39 million additional tons to supply the 54 new distilleries cited above, for the U.S. alone we are looking at a growth in demand of 136 million tons of additional grain from the 2007 harvest if we are to avoid a further decline in stocks.

For a world where the growth in the grain harvest has averaged scarcely 20 million tons per year since 2000, the chances of such a huge jump in the harvest next year are not good, even with the stimulus of high grain prices. Beyond this, farmers must contend with spreading shortages of irrigation water and the prospect of even more intense heat waves as the earth's temperature rises.

Escalating competition for the U.S. corn crop is already driving up prices. In some corn-growing states such as Iowa, Indiana, and South Dakota, completion of the plants under construction and those planned means distillery requirements would take virtually the states' entire corn harvest.

The local competition between new distilleries, on the one hand, and more traditional feedlots, dairies, and pork, poultry, and egg producers, on the other, will be intense. To some degree, the one-third of the corn byproduct that emerges from the distillery as distillers grain will offset the loss of corn for feeding. Distillers grain, consisting mostly of fiber and protein and containing little energy, is, however, much better suited to feed beef and dairy cattle with their unique digestive systems, than pigs and chickens.

Corn importers like Japan, Egypt, and Mexico are also worried that the likely reduction in U.S. corn exports, which are 70 percent of the world total, will disrupt their livestock and poultry industries. In some importing countries in sub-Saharan Africa and in Mexico, corn is the staple food. In the United States corn supplies sweetener for soft drinks and is used in breakfast cereals, but most corn is consumed indirectly. The milk, eggs, cheese, chicken, ham, ground beef, ice cream, and yogurt in the typical refrigerator are all produced with corn. In effect, the refrigerator is filled with corn. And the price of every item in the refrigerator is affected by the price of corn.

Wheat and corn prices have climbed by a third or more over the past several months. Corn and wheat futures are both trading at 10-year highs. With corn stocks at the lowest level on record and demand soaring, corn prices appear headed for historic highs. Wheat and rice prices will likely follow corn prices upward. By the end of 2007, the emerging competition between the 800 million automobile owners who want to maintain their mobility and the world's 2 billion poorest people who want simply to survive will be on center stage. If grain prices do climb to all-time highs, food riots and political instability in lower-income countries that import grain, such as Indonesia, Nigeria, Mexico, and scores of other countries, could disrupt global economic progress.

This clash between motorists and people over the food supply is occurring when 854 million of the world's people are chronically hungry and malnourished and some 24,000 of them, mostly children, die each day. The U.N. Millennium Development Goal of reducing by half the proportion of people suffering from hunger by 2015 is now failing as the number who are hungry edges upward, and it could collapse completely in the face of the food-for-cars onslaught.

The attempt to solve one problem--growing U.S. dependence on imported oil--is creating another far more serious problem. Fortunately this can be avoided. The 3 percent of U.S. automotive fuel supplies now coming from ethanol could be achieved, several times over and at a fraction of the cost, by raising automobile fuel-efficiency standards by 20 percent.

On the food-versus-fuel issue, the world desperately needs leadership--a strategy to deal with the emerging food-fuel competition. As the world's leading grain producer and exporter, as well as its largest producer of ethanol, the United States is in the driver's seat.