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By Ezra Klein
Sunday, June 13, 2010

How much does a gallon of gasoline cost?

It seems like an easy question. You might ask whether I mean regular or
premium, and where in the country I'm buying. Beyond that, though, the price
is displayed in giant numbers on most main roads. It's such common knowledge
that we ask politicians to rattle it off to show that they retain some
minimal awareness of the world they claim to represent.

But as the sludge choking the Gulf of Mexico shows, nothing is easy when it
comes to oil. Not even the price. In fact, especially not the price.

Most of us would call the BP spill a tragedy. Ask an economist what it is,
however, and you'll hear a different word: "externality." An externality is
a cost that's not paid by the person, or people, using the good that creates
the cost. The BP spill is going to cost fishermen, it's going to cost the
gulf's ecosystem, and it's going to cost the region's tourism industry. But
that cost won't be paid by the people who wanted that oil for their cars.
It'll fall on taxpayers, on Gulf Coast residents who need new jobs, on the
poisoned wildlife on the seafloor.

That means the gasoline you're buying at the pump is -- stick with me here
-- too cheap. The price you pay is less than the product's true cost. A lot
less, actually. And it's not just catastrophic spills and dramatic
disruptions in the Middle East that add to the price. Gasoline has so many
hidden costs that there's a cottage industry devoted to tallying them up. At
least the ones that can be tallied up.

Topping that list is air pollution, which we breathe in whether or not we
drive. Then there's climate change, which is difficult to slap a price tag
on because it involves such esoteric calculations as how much your
grandchild's climate is worth. There's traffic congestion and accidents,
which harm drivers and non-drivers alike. There's the cost of basing our
transportation economy on a resource that undergoes wild price swings.
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Some of the best work on this subject has been done by Ian Parry, a senior
fellow at Resources for the Future. His calculations -- plus some data from
other sources and studies -- suggest that adding all the quantifiable costs
into the price of oil would increase the cost of each gallon by about $1.65.
According to the Energy Information Administration, the average price of a
gallon of gas was $2.72 last week. It should really be as high as $4.37.

That, however, is almost certainly an underestimation. There are plenty of
costs that we just don't know how to put a price on. How much of our
military policy is dictated by our need for secure oil resources? How much
instability is created by our need to treat oil-producing monarchies such as
Saudi Arabia with kid gloves? How much is the environment worth in a poor
country that would prefer oil investment to air-quality regulations?

Or take the spill in the gulf. What's the economic value of a whale? Of a
pelican? Of plankton? The nation's been horrified by the photographs of
oil-soaked wildlife, but how much is not being horrified actually worth to
us? And is not knowing about the problem enough to solve it? One reason
we're drilling wells far offshore and in countries with poor safety and
environmental records is that we don't want oil companies mucking about in
the shallow waters near our homes, or on public lands such as the Alaska
National Wildlife Reserve. But as Maureen Cropper, an environmental
economist at the University of Maryland, notes, importing oil means
exporting the damage associated with drilling for oil. When trying to put a
price on that damage, do we think it varies by country? Is Kenya's
environment worth less than our own?

For all the complexity of calculating the true cost of gasoline, however,
it's unclear that it matters as much as some might think. When I started
researching this column, my working assumption was that a world in which
gasoline's total costs were represented at the pump would be a world in
which our consumption of gasoline was radically different. But almost all of
the experts I spoke to said that wasn't true. In part, that's because years
of regulations and innovations have made us much more efficient at finding,
extracting, refining and using oil. If an energy source as dirty as coal had
to pay its true cost, we'd pretty much stop using it. Disasters aside,
that's not the case with oil. Oil might be cheap compared with its true
costs, but adding those costs in wouldn't necessarily make it unaffordable.
Our behavior might change at the margin, but we'd still be an oil-thirsty
society.

That gets to the bigger issue, which is that energy sources are cheap or
expensive only in relation to one another. And the heaviest anchor beneath
our reliance on oil is that, at this point, there's nothing to replace it
with.

"We're pretty much stuck with our dependency on oil," Parry says. "We don't
have any substitutes. Even if we hugely increase the price on oil, we'd only
have limited impact on it. People need to drive and get to work."

That's not to say there'd be no benefit to forcing gasoline to pay its full
freight. Increasing the cost of oil could make other energy sources cheaper
in comparison, and if the mechanism were a tax that would fund development
of alternatives, that would hasten our transition. But it is the speed with
which we can discover and refine those alternatives, more than the price of
oil, that will decide our energy future.

The question, in other words, isn't just what a gallon of gas costs. It's
what a gallon of anything that can replace gas costs. Maybe that's what we
should start asking politicians.
--
Eric D. Schwerin
Rosemont Seneca Partners
(202) 333-1880
eschwerin@rosemontseneca.co