The High Cost of Underestimating the Cost of Doing Business
If you provide a product or service that is more environmentally responsible than those of more established competitors, how do you differentiate your offering? Part of the way you may do so is through education about the hidden costs of products or services that were created with little concern for the environment. When governments work to ensure that these costs remain hidden, however, it can make your job much more difficult.
A new posting on Grist on faulty projections of future oil prices and a separate estimate of the true cost of oil highlight two aspects of the danger we face when estimates of the cost of doing business are set too low.
In the Grist posting Oil Futures, Eric de Place of the Sightline Institute examines recent oil price projections that proved to be wildly inaccurate. He focuses on two official predictions made in 2007 and 2008 by the U.S. government’s Energy Information Administration (EIA). The prediction made in 2007 projected three alternative scenarios for oil prices out to 2030. Even in EIA’s “high price” scenario, oil prices did not reach $100 per barrel until around 2030. The “low price” and “reference” scenarios projected a drop in oil prices, followed by a gradual rise to about $40 and $60 per barrel respectively in 2030. (All prices were in 2005 dollars to factor out inflation.)
Of course, oil prices hit $100 per barrel at the start of 2008, about 22 years early by the EIA’s 2007 “high price” projection. So in 2008, they went back to the drawing board and came up with new forecasts… which proved they hadn’t learned very much. This time, their “high price” scenario forecast that oil prices would rise until they approached $120 per barrel in 2030. Oil prices under the “low price” and “reference” scenarios were increased slightly from the previous year’s forecast. Naturally, the market for oil again failed to follow the government’s forecasts, and the $120 per barrel level was reached and surpassed in a matter of months.
As de Place observes, the EIA “seems to have a hilariously persistent tic,” noting “It’s as if the forecasts are impervious to reality.” As oil prices rise, it continues to insist that the most likely scenario is for prices to fall to earlier levels, or at worst rise very slowly over the next two decades.
The consequences of such gross underestimates of oil prices, however, can be dire, as de Place suggests:
“All else being equal, forecasts of lower oil prices will tend to raise the predicted costs of climate policy. In part, this is because cheap oil means lots of consumption and intractable behavior. But if oil prices are high in the future, as they are now, then a cap and trade program might add only small costs — or even result in savings. So the EIA’s perpetual sunshine-optimism about future oil prices might create a big distortion of the cost of sensible carbon reductions.” [Emphasis added.]
In other words, when our government states that current oil prices are an anomaly and will be coming down soon, it encourages bad decision-making, partly by making the promotion of energy efficiency and renewable energy seem costly and short-sighted.
But even current market prices of around $127 per barrel greatly underestimate the full cost of oil, compounding the problem. The 2007 report The Hidden Cost of Oil (PDF) by Set America Free calculated several costs of oil that are borne indirectly by citizens, but not included in the market price. These include military spending to secure oil shipping lanes and a variety of other costs. The report concludes that these hidden costs amount to $825 billion per year, equivalent to adding $8.35 to the price of a gallon of gasoline produced from Persian Gulf oil. And this does not even include the environmental costs of oil!
Entrepreneurs who develop clean alternatives to destructive production methods will always have a need to educate people about the hidden costs of doing business as usual. They can do so on their own as well as through organizations of responsible businesses in their field and by partnering with activists and advocacy groups. However, there is both a responsibility and a business imperative to take another step and demand that government adopt accurate ways of assessing the true cost of doing business.
Evan
People in this country need a massive re-education about true energy costs. In Europe where they have been paying $6 per gallon for gas for years, it is closer to the true cost (of course that figure is greatly outdated now) At the time the $6 per gallon was the norm, we were screaming that the price went up to $1.29. Riiiigghhht.
Even so, still today all the discussion is about how we can reduce the COST of a gallon of gas instead of how we can reduce our USE of a gallon of gas.
Even though I own a Prius I still try not to drive very much (I am physically unable to ride a bike) And I bought that car, not just because it gets great gas mileage but because I also wanted to reduce my ‘carbon footprint’. Most people are not even aware of what their carbon footprint is, let alone what contributes to it and how to reduce it.
Thanks for starting a discussion about true costs. Something I think we are all going to have to start understanding and living with.