CEP: Editorial - Energy Cost Averaging

Last year, when we chose biofuels as the topic for this issue’s Society for Biological Engineering (SBE) supplement, we did not anticipate the precipitous drop in oil prices of recent months. As we were pulling the articles together, guest editor Mark Holtzapple expressed concern that oil prices would be low when the issue appears. “If readers do not think too deeply, they might say ‘These academics are sure out of touch. Don’t they know oil prices are low?’”

Price is certainly critically important — but focusing on current prices is shortsighted. Low prices tend to drive high-cost producers out of business; they also spur increased demand. The resulting higher demand and lower production trigger price increases. The higher prices motivate higher-cost producers to get back in action; they also motivate users to cut back and reduce consumption. Reduced demand then leads to price drops. The new lower prices once again drive high-cost producers out of business and spur increased demand. And the cycle goes on and on, but with one important caveat: Each new low price is usually higher than the previous low price, so the overall trend is upward.

Demand is also on a net upward trajectory that periodic price dips do not reverse. In “The Need for Biofuels” (pp. 36–40), Holtzapple and coauthor Bruce Dale remind us that the amenities (wealth, education, health care, mobility, etc.) of modern life in the developed world depend on abundant energy; remove abundant energy and the modern world disappears. They argue that even with efficiency improvements, maintaining our current standard of living will require sustained energy consumption; providing these amenities to an increasing world population will involve corresponding increases in energy consumption. Where will that energy come from?

Now, most of it comes from fossil resources. We currently have about 85% of our energy eggs in the fossil fuel basket. While that might make sense today, we need to take a long-term view that focuses on achieving energy security through diversification.

When will oil prices go up? How far will they go? When will they drop again? If I knew the answers to those questions, I’d be rich — like an investor who successfully times the market by following a buy-low/sell-high strategy.

Although that strategy might work for someone with a high risk tolerance, I prefer dollar cost averaging — investing a fixed amount on a regular schedule to smooth out the market’s ups and downs. Because energy prices, like stock prices, can be volatile, this approach should work well for energy investing.

In fact, in 2008 — when the price of gas seemed to jump five or ten cents between the time I went to work in the morning and came home at night — that’s the approach I took to filling my gas tank. In the long run, I did better by topping off my tank once a week regardless of the reading on my fuel gage.

It takes time to research, develop, scale up, and produce biofuels. I would argue that now is the right time to be working on biofuels, so that when oil prices rebound — as they are sure to do — we will have options. In addition to looking for new sources of oil and gas, let’s put effort (and money) into alternatives, so we will have them when we need them.

The energy industry should borrow a page from the investor’s playbook by dollar cost averaging to create a diverse portfolio of energy sources. This will help to ensure we have a reliable supply of energy available at a reasonable and predictable cost.