In Friday’s print version of the Wall Street Journal, Katherine Kranhold writes (GE’s Water-Treatment Group to Unveil Its First Major Project, 6/24/2005):
George Oliver, Chief Executive of GE’s water and process technologies business, says “As water scarcity increases, the cost of water increases. The desalination and reuse [of] water becomes a very attractive economic solution."
The cost of a depletable resource increases as the stock is depleted for two reasons: 1) Extraction costs increase, and 2) The value of the resource left in the ground.increases. The first cost makes sense, it is easy to pick the low hanging fruit but more expensive to harvest the difficult to reach fruit. The second cost is more subtle, but just as important.
To understand why the value of the resource left in the ground must increase, think of the stock of a depletable resource as a giant savings account. When will you draw down the savings? When the value of that resource left in the ground is less than the value of the money you could receive for that resource if it were extracted. For each unit of the resource left in the ground the owner has two choices, leave the resource there and let it’s value grow, or extract the resource, sell it and invest the money elsewhere.
In addition to being able to recover the ever increasing cost of extracting the resource, the value of the resource left in the ground has to increase at least at the rate of interest that could be earned on the alternative investment. Whether it’s because it costs more to extract, or because it costs more to leave it in the ground (or both), the price of a depletable resource will increase over time (Unless new stocks of the resource are discovered in which case the price will drop temporarily, see John Whitehead’s post on this). As the price increases, substitute technologies become more economically attractive.
Government policies may be able to influence the rate at which these alternative technologies become economically attractive (by subsidizing development of alternative technologies, or taxing the use of existing technologies), but government policies may also be able stretch out the time it takes to make these technologies economically attractive (price controls on the depletable resource for example). If economic models are right, market forces will inevitably cause the price of depletable resources to rise. Government policies can only speed up or slow down this process.
With that in mind, let me modify the above quote from George Oliver:
As [oil] scarcity increases, the cost of [oil] increases. [Alternative energy technologies] become a very attractive economic solution.
Will price adjustments caused by rational economic behavior lead companies to invest more in alternative energy technologies when they become an ‘attractive economic solution?’ It looks like it’s working for water.
