How to cope with the cheapest energy ever - make it expensive

The price of oil has fallen and is still falling, with fatal consequenc es for the environment but, says Hamish McRae, there is a way out of the trap

Even silver clouds sometimes have a dark lining. As the markets yesterday signalled, in their own inimitable way, we're in for a period of very low oil prices. They reckon that if the apparent settlement in Iraq leads to the lifting of UN sanctions on that country's exports, even more oil will get pumped on to the already swamped world market - for the oil price is now as low in real terms as it was before it quadrupled in 1973-74. Indeed, it is just about as low in real terms as it has ever been since the world first starting using mineral oil in large quantities more than a century ago.

Expect this situation to continue. The main determinant of energy use in the world is economic growth, and East Asia, which has accounted for two-thirds of all growth since 1990, is currently stalled. Cheap oil means cheap energy. Oil, and gas (which follows the oil price pretty closely) account for roughly two-thirds of the world's energy supplies, and coal makes up most of the rest. Only 10 per cent of the world's energy comes from non-fossil fuels, mostly nuclear and hydro-electric power. In many ways we should welcome a plentiful supply of cheap energy; it is a crucial element in determining living standards everywhere.

But in terms of the effect on the environment, this is very bad news. We cannot rely on the price mechanism to control our energy use. The market, when it is on your side, is a wonderfully powerful ally. Anyone who can remember the two oil shocks will recall how people cut energy use. The immediate effect was for people to drive less and turn down the thermostats, but there was also a longer-term effect, as car manufacturers focused on fuel consumption, and architects on the energy efficiency of buildings. From now on, though, the market will be against savings of this sort.

We can already see how hard it is to fight the market. The well-meaning legislation in the US to increase fuel efficiency has mainly had the effect of producing gutless cars, which in turn has encouraged real Americans to buy light trucks and four-wheel-drive vehicles instead. Of course, these use much more fuel, but fuel is so cheap that no one cares too much.

We should not, however, sneer at US hypocrisy. Our own deputy prime minister has recently publicised the fact that he is exchanging his regular official Jaguar for a new one fuelled by natural gas. But that does not make his Jag significantly kinder to the environment, or any more efficient. Gas is cheaper only because the tax is lower, and the global resources of gas are almost as tight as those for oil: around 52 years' supply compared with about 45 years'. (In fact, since up to one-third of the energy a car uses in its lifetime is used to manufacture it, the true environmentalist would try to use an old car, not a new one.)

So what will happen? We have the prospect of another generation of cheap energy, with all the inevitable environmental problems that will result. The only things that might change that - such as a real war in the Middle East - are too horrible to contemplate. Is there no way out?

Mercifully, there is a way forward. The solution comes in two parts. The first is to apply the market mechanism through taxation. Countries need to tax energy a lot more. Governments are already desperate for revenue, for they can see that their traditional sources are going to be relentlessly cut away. Companies are already able to shift their operations around the world to minimise their tax payments and extract the maximum in incentives to invest. Increasingly, rich individuals are doing the same. The more the tax burden is shifted to employers, the more they export the jobs.

The more it is put on consumption taxes such as VAT, the more the black economy grows; in Italy it is now about a quarter of the economy.

Energy taxation, by contrast, is remarkably difficult to evade. Fuel for vehicles is tightly controlled. So, too, is electricity and gas. There may be powerful political reasons for not wanting to increase energy taxation, but attitudes there can be changed - there used, after all, to be a strong political lobby against taxing tobacco more heavily - provided people feel that the extra revenues will not disappear into the usual black hole and be wasted. If environmental taxes were not used to spend more, but specifically targeted to reduce taxation elsewhere, then they might even become the one form of additional taxation that was positively popular.

However, while there are some things that can be done to conserve energy within national boundaries, others - such as taxation of aviation fuel - need international co-operation. That leads to the second part of the solution: we need to create a culture of conservation.

One of the difficulties politicians face is taking into account the interests of future generations, both people too young to vote now and (still more difficult) the unborn. These voices are unheard at election time. Yet individually we do care about posterity. We plant gardens and trees that won't reach full maturity in our lifetimes; we seek to leave something for our children; we support charities that try to protect endangered species.

Somehow politicians need to connect the interests of future generations to those of their present electorates. One way of making this connection real is to focus on the needs of the environment, and in particular the duties of each generation to treat it in a responsible way. We can all envisage a world 25 or 30 years hence when even more acres of beautiful countryside are covered with concrete, when our air is even dirtier than it is now, and when there have been long-term changes to our weather as a result of a build-up of greenhouse gases. Governments can use this aspect of public concern about the future to draw people's attention to something they find much harder to accept: that governments now should be running budget surpluses, paying off debt as fast as they can, and encouraging people to save for their own pensions so that the next generation of people of working age will not have to pay even more to support the growing army of the retired.

So the prospect of a generation of cheap energy is in one sense a threat. Miss the chance to be wise about energy use now, and we end up with a nastier environment a generation hence. But because everyone can see that, it is also an opportunity. It is an opportunity for those with influence - not just politicians but opinion-formers in general - to show that we can connect the interests of one generation with those of the next.

We do that by accepting that the benefit of cheaper oil should be passed to society as a whole, in the form of higher energy taxes.