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Cheap Oil:
Good News & Bad News

Paying less at the pump feels great, but there's a real downside. Here's why gas at $2 a gallon isn't the cause for celebration it appears to be.

By Patricia Smith

When gas prices soared last summer, Doug Guidry of Vinton, Louisiana, gave up drag racing and boating. Billy Castaneda put off car trips from Vinton to Houston to see his grandchildren.

Now, with gas about $2 a gallon (less than half the summer peak of more than $4 a gallon), both men are hitting the road again—and they have plenty of company.

The global financial crisis and deepening recession is the main reason the price of oil has dropped so far, and so fast—to about $45 a barrel from a record high of $145 last summer. As consumers and businesses have cut back their spending, factories have slashed production, and fewer ships and planes are needed to move goods and people around the world.

It all translates into less demand for oil. And, as with any product, the price falls along with demand. Great news, right? Well, yes and no.

Yes, it's a lot more fun filling up your car when gas is $2 a gallon than when it's $4. A driver who buys 50 gallons a month has been saving $4 a day compared with last summer. For the nation as a whole, that's a daily savings of around $1 billion—which means a lot more money in Americans' wallets at a time of recession.

Cheaper oil has also had a beneficial effect on the international political scene: High oil prices boosted the clout of autocratic leaders of oil-rich countries like Venezuela, Iran, and Russia—the Axis of Diesel, as some have dubbed them. Presidents Mahmoud Ahmadinejad of Iran, Hugo Chávez of Venezuela, and Vladimir Putin of Russia used their oil billions to buy support at home and influence around the world.

"The producers are experiencing a reverse oil shock," says energy analyst Daniel Yergin. "As revenue went up, government spending went up and expectations of a continuing windfall led to greater and greater ambitions. Now they are finding how integrated they are into this globalized world."

The Downside

But as counterintuitive as it sounds, there's also an enormous downside to lower oil prices as the U.S. tries to reduce its dependence on oil, most of which comes from unreliable, sometimes hostile, places like the Middle East and Venezuela, and all of which contributes to global warming.

Remember all the talk last year, as oil prices rose, about Americans giving up their gas guzzlers for smaller cars or more expensive hybrids? All the discussion of moving to alternative sources of energy, like wind or solar, that not only pollute less but also aren't under the control of "petro-dictators," as New York Times columnist Thomas L. Friedman calls them?

You hear a lot less such talk today because it made a lot more economic sense with oil at $145 a barrel than at $45.

Dozens of oil and gas exploration projects, from North Dakota to Brazil, have been suspended in recent months. Domestic oil drilling, which also boosts America's energy independence, could drop by 41 percent this year. And investment in alternative technologies—expensive and risky even with oil at $145 a barrel—could be dealt a crippling blow at $45 a barrel.

And like Doug Guidry and Billy Castaneda, people are going back to their old, energy-inefficient habits: driving more and thinking less about avoiding big, gas-guzzling SUVs.

"Driving habits die hard, and they can reincarnate quickly," says Christopher R. Knittel, an economist at the University of California, Davis. He notes that the U.S. has been down this road before: In the late 1980s, after a period of high prices encouraged conservation, "as gas prices fell, there was no real incentive to drive less anymore. If oil prices continue to fall and the economy recovers, I would expect consumers to return to wanting larger and less fuel-efficient cars."

The biggest danger in returning to old energy-guzzling ways is that the U.S. will end up just as dependent as before on environmentally unsound and unreliable sources of foreign oil.

Many economists say the way to solve our energy problems is a hefty carbon, or gas, tax to keep prices high. That would give Americans the incentive to buy more efficient cars and appliances, and businesses the incentive to invest in alternative energy.

When consumers were struggling to pay $4 a gallon, it was hard to stomach the idea of those prices going even higher by adding on a carbon tax. But now that prices have fallen so much—and we now know that most of us are capable of paying more, even if we don't like it—the idea of a carbon tax may be easier to sell.

"This is [Obama's] best window of opportunity to impose a gas tax," says Thomas Friedman.