Wednesday, August 13, 2008

Is gas really that expensive?

Sounds like a no-brainer, right? Even if you understand the reasons for the increase in gas prices over the past couple years, you probably think it's high enough.

Despite some recent decreases in the price of crude, gas prices have barely budged. Surely gas isn't really worth more than $1.30 a liter (in Nova Scotia). Those gas companies are just getting rich at the consumer's expense. Right?


The truth is that the market price for gasoline doesn't begin to cover the true cost of its use. That $1.30 goes toward the cost of discovering, pumping, and refining the oil into gasoline, and then the cost of delivering the finished product to your local gas station, as well as any taxes (which can be considerable, depending on which country you live in).

But that $1.30 doesn't begin to cover the costs of climate change, various tax subsidies for oil companies, and even the long term health care costs resulting from air pollution. Depending on who's doing the calculation, those hidden costs could amount to as much as three or four times the market price that we pay for gasoline.

This is the problem with waiting for the market to solve our environmental problems; the true cost simply won't become apparent until many years in the future. These costs are generally referred to as externalities in economics lingo.

The classic case study is that of a factory which pollutes a nearby river. The costs of this pollution are not reflected in the firm's balance sheet, but the environmental damage is considerable for the town; some people die of sickness related to the pollution, and the cleanup is expensive. The market has no way to account for these external costs, so government regulation is necessary to ensure that the firm accounts for its own externalities, either by paying for cleanup or improving their standards so they no longer pollute the town's river.

So a carbon tax on gasoline like the one the Liberals are proposing would be an attempt to account for the externality, but we shouldn't fool ourselves into thinking that even a strident carbon tax will fully nullify the true cost of burning the stuff. I don't mean to be a broken record, but the only long term solution is to drastically cut back on our use of fossil fuels.

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