The Magazine

A Good Thing Obama Could Do

For a change.

Mar 2, 2009, Vol. 14, No. 23 • By LAWRENCE B. LINDSEY
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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.