The rapid rise in gasoline prices caused by oil speculators bidding up the price of crude oil in response to chaos in Arab lands will no doubt spur development of alternative energy, i.e. alternatives to oil.   This is a field loaded with land mines. 

The basic problem lies in the fact that, while Saudi Arabian oil fetches near $100 a barrel on world markets, it costs about $2 a barrel to produce.  As I mentioned in another article, Saudi Arabia has plenty of spare capacity to replace Libyan oil output.  It appears that Saudi has about 5 million barrels a day in spare capacity which means it could replace Libya, Algeria and Iraq if needed.  That spare capacity also means that Saudi Arabia can in an instant drop the price of oil worldwide, it only has to cover $2 a barrel to produce. 

The point is that, while alternative energy may be attractive and efficient when oil is at $100 a barrel, it will be a drug on the market if oil prices fall by say half.  Think this is just speculation?  This is exactly what happened to then  President Carter’s alternative energy program adopted in the late 1970s.  When prices rose spectacularly,  made possible by oil exporting states colluding to set production and thus prices, alternative energies were made price competitive.  However, not too long after Carter’s program started to have success, the the exporting countries raised producton quotas, thus lowering  prices to a point that rendered all the new alternatives non-competitive.

The key to making alternative energy a viable investment is to guarantee prices for the energy produced.  One example of this is the many windmills providing electricity between Los Angeles and Palm Springs.  Each mill is individually owned as a separate company.  By law the power supply companies have to buy all electricity available from these individually owned windmills at a set price,even if the supply company can buy cheaper electricity elsewhere.  Thus the investment was guaranteed a set income and the windmills became the investment of the day promoted by an army of vendors.  Unfortunately the windmills proved to be very expensive to maintain and the investments soon fell out of favor.

This practice of requiring power supply companies to buy all electricity produced by alternative energy also led to the very complex market for electricity that became dominated by Enron that ended up as one of the largest financial disasters in America’s history. 

Again, developing alternative energy based on the current high price for oil is a risky business and no progress can be made without guarantees for these new investments.  My present partner in a wine business also has a large joint venture to supply electricity from solar panels manufactured in Germany.  Before he met with the governor of New Mexico I advised him to get answers to two questions, what will be the guaranteed price for the electricity produced by the panels and what subsidies will the state offer the project.   If he can get a guaranteed price and subsidies, then this is a viable business.  If not, he runs the high risk of seeing the investment made totally worthless by a sudden drop in oil prices.

While this takes care of the risk for the investors, how can public officials guard against political risks?   Specifically, if the governor guarantees a price for electricity from this solar panel investment, what will happen when a fall in oil prices means the consumer could buy electricity produced from oil at  half the price he is paying for the solar panel supplied electricity?  Will the consumer accept the higher price in order to lower dependency on oil or will he throw out the governor for sticking him with a higher price?

Easy to promote alternative energy when oil tops $100 a barrel, but beware the economic and political risks, and take measures to guard against these.