Barack Obama met his President's Day deadline for getting a stimulus bill to his desk. As soon as it was passed, the administration started backpedaling on how stimulating it will actually be. Instead of January's projection of 4 million jobs and unemployment peaking in the third quarter of 2009, White House officials are now on the talk shows saying that it will take years for its positive effects to show up. That is kind of late for admitting that their critics' observations about the bill were right. Maybe they'll do better next time, and if they keep on schedule we'll soon find out, as congressional action on setting a new energy policy should occur next month. Let us hope that March's action is more energizing than February's was stimulating.
What the administration and congressional Democrats didn't seem to get is that good policy is not about "shock and awe" with big numbers. Sharp pencils are needed to make sure the numbers actually work. And good policy starts with a clearly stated rationale for why government involvement is necessary.
When it comes to energy policy, the rationale is twofold. First is the adoption of a basic operating standard for the country as a whole. Second is the presence of an externality--dependence on foreign oil--where the true costs and benefits to the nation of using oil are not reflected in the price set by the market.
Consider the case of operating standards. The chemical makeup of the gasoline on which we run our cars is selected by government working in concert with the oil industry and the automakers. It really makes sense for it to be that way. Imagine if cars made by GM could run only on gasoline made and sold by Exxon while cars made by Ford ran on Chevron gasoline and Toyota ran only on Shell. Or imagine if Texas demanded one kind of car with one kind of gasoline while New York demanded another. Actually, some in Congress tried to create just such a Balkanized gasoline market by allowing each state to set its own rules, but the Bush administration blocked it. Standard setting makes sense.
There can be more than one standard, but there is a limit. The piece of the market that is subject to a given standard must be large enough to make using that standard economically viable. And, as the gasoline example demonstrates, economic viability means that you have to have a big enough part of the market to cover all areas of the product involved--enough cars to justify a car maker, enough gasoline stations to justify a brand of gasoline, and so forth. Congress is now confronting exactly this problem with regard to the transformation of a portion of the nation's trucking fleet from diesel to natural gas.
Such a conversion makes real economic sense. Take a sharp pencil to the economics of running a big 18-wheeler. A diesel powered truck costs about $105,000. A natural gas powered truck costs $175,000. A diesel powered truck gets about 6 miles per gallon and drives 100,000 miles per year, burning 17,000 gallons of diesel. A truck driving the same distance on natural gas would burn 2,100 cubic feet of natural gas. Diesel now costs about $2.50 per gallon and was much higher earlier this year, but even at the lower fuel price that means $42,500 in fuel costs. Gas at about $5 per cubic foot makes the annual fuel costs of the natural gas vehicle $10,500.
The fuel savings from using a natural gas truck is thus roughly $32,000 per year, which would pay for the added cost of the truck in just over two years. Call it roughly a 40 percent annual rate of return on money invested. So why, even in these credit starved times, doesn't the trucking industry begin the switch from diesel to natural gas?
This is where standards come in. A long-haul truck has to have a place to refill its tank, and there are about 9,600 truckstops nationally where most of them refuel. For the conversion of the trucks to work, these truckstops would need to add natural gas refueling to their existing diesel capacity. This isn't cheap, about $1 million each just to add natural gas, perhaps twice that to build a whole new station. So, the investment in refueling infrastructure would be roughly $10 billion.
It obviously makes no sense for an individual truck owner to make the switch. Even a single large trucking company with a fleet of, say, 20,000 trucks, would find the additional refueling investment way out of reach. And of course, owners of truck stops will only make the investment once a critical mass of trucks makes the conversion to natural gas. You might call it a chicken and egg problem, but it comes down to getting over the economic hurdle of setting a standard.
One way of doing this involves a part of what is widely known as the Pickens Plan, after famous Texas oilman T. Boone Pickens. Pickens proposes giving buyers of natural gas powered trucks a $70,000 tax credit for the next three years. That makes the decision to buy a natural gas powered vehicle almost a no-brainer. Pickens estimates that in three years we would have a critical mass of 350,000 natural gas powered trucks. With that prospect, there is a clear incentive for the nation's truckstops to provide the refueling capacity the fleet will need. Of course, once you get the refueling capacity in place, it becomes quite easy for future truck purchasers to take advantage of the cost saving--and 40 percent return on investment--that buying a new truck powered by natural gas provides even without the credit.
This brings us to the second reason for government involvement. The total three year cost of this tax credit--$70,000 for 350,000 trucks would be about $25 billion. That money is a direct transfer from the taxpayers of the nation to those pioneering truck fleet owners who are the first to adopt natural gas powered vehicles. Those same truck owners will also be capturing the saving from lower fuel costs. The reason that it is in the national interest to provide this tax break is that it will also provide a major saving to the nation's oil import bill and take us a significant way toward national energy independence. This is where the word "externality" comes into play; in particular, the benefits to the country of being closer to energy independence.
Again, consider some math. If just 350,000 trucks make the switch from diesel to natural gas over the next three years, America will end up importing 150 million fewer barrels of oil each year. How much is national energy security worth? Some commentators have suggested a $1 per gallon gas tax. Stated differently, people are saying that there is an "externality" in the form of benefits from national energy security that is worth $1 for every gallon of gasoline we use.
If you apply that measure to the Pickens Plan, the numbers become truly staggering. One dollar a gallon is worth $40 for each barrel of oil not imported. That amounts to $6 billion per year each and every year into the future on the plan's $25 billion investment--an annual rate of return of 24 percent. That's if you stop at just 350,000 trucks. When additional natural gas powered trucks are added to the fleet after the credit expires and after we already have the critical mass of trucks needed to justify refueling stations, all the energy saving gains come at no additional cost to the government. If one quarter of the nation's 4.5 million truck fleet converted--as might be expected after about 10 years or so--the total saving to the country would be three times as large. Even a much lower "externality" cost to energy security produces a significant rate of return. At 25 cents per gallon the real return is at least 6 percent, twice the current government borrowing cost.
So if the administration and Congress really want to produce good policy, rather than merely grabbing headlines by throwing taxpayer money around, they might do some similar arithmetic on their ideas. Converting the truck fleet to natural gas shows the approach taken by a smart businessman, not a politician. Moreover, the Pickens Plan contains a clear justification for government involvement--standard setting that the private market cannot do by itself. If it could, the fuel savings on natural gas trucks would already have driven the private market to use natural gas in large fleets.
The stimulus bill had provisions for the insulation of public buildings and similar energy retrofits. If this actually make sense from an energy saving point of view, one has to ask why government didn't do it in the first place. There is no standard--setting issue with regard to insulation. The heating and cooling of America's buildings, moreover, is not done with imported oil. Less than 5 percent of all the oil we import goes to such purposes. So the energy provisions of the stimulus bill were more about throwing other people's money around and grabbing headlines in the process than about energy security. Let's hope Congress and the administration take their time, pull out a sharp pencil and a calculator, and do a better job next time.
Lawrence B. Lindsey is a former governor of the Federal Reserve. His most recent book is What a President Should Know . . . but Most Learn Too Late.