Oil prices have dropped significantly; over $15 per barrel in just three days. Reports indicate that price slide is expected to continue in the long term. Why does it seem as if the oil price bubble might finally be popping?

1)Demand is way down. At this time of the year in the northern hemisphere, one would expect that demand for gasoline and fuel oil / natural gas to run peaking power plants would be at historic highs. Just the opposite is occurring. Oil and gasoline inventories are higher than normal, indicating a significant drop in demand. Natural gas inventories are at a 20 year high for this time of the year, indicating that the electric power industry isn’t needing to use costly gas-fired peaking power plants, because people aren’t using their air conditioners as much, even in a heat wave.

2) The Bush administration, having realized a negotiation success with North Korea, is apparently at least signaling the intent to take somewhat the same approach with Iran. It’s been recently announced that the U.S. will open an “interest section” in Tehran (not an embassy, but perhaps a first step in that direction), and that senior U.S. negotiators will sit down with their European counterparts and officials from Iran.

Both developments are positive, at least in terms of impact on crude oil and well-head natural gas prices. Does the lower cost translate into relief at the pumps (or in heating bills this winter)? Don’t count on a significant reduction in retail energy prices any time soon, but I think that American consumers have been so impacted by skyrocketing energy prices that demand will continue to sag.

This is all good - but is it a temporary downward demand response, or will we simply fall back into old bad habits once the oil markets hit some kind of equilibrium? Hard to say. Here’s an idea…

Instead of the “gas tax holiday” that was being previously floated by all presidential candidates (and many congressional members), how about an increase in the gas tax - or at least pegging taxes to a benchmark number? The U.S. has the lowest gasoline tax, by far, of all industrialized nations in the world. At 18.4 cents per gallon, it’s a pittance compared to the U.K, France, or even Canada.

Here’s a graph from Petro Canada that I published in a prior post. It explains some of the disparity in gas prices around the world (in countries where the government doesn’t subsidize gas prices).

For the purposes of my tax increase argument, let’s say that gasoline is $4 / gallon right now, and of that cost, about 0.5% is the federal gas tax. And let’s posit that the retail cost of gasoline starts to drop. What if the tax “floated” such that the price of gas at the pump remained around a benchmark of $4, and if the retail price once again exceeds $4, the tax bottoms out at 18.4 cents? Perhaps tax revenues in excess of 18.4 cents could be directed to fund alternative energy development.

In any case, the crux of my tax argument is to keep us from falling back into bad habits. It’s only natural that if prices fall, demand for our finite fossil fuel energy sources will increase once again. We’re adjusting - albeit painfully - to the current cost of energy. Many of us have adjusted by breaking old usage patterns, but these behavioral adjustments might not be permanent if prices drift back down and we fall back into the same old ruts (in fact, big oil is counting on this kind of “lifestyle resumption”).

I know, I know, I’m dreaming. There isn’t a politician in Washington who would have the balls (or ovaries) to introduce legislation for a sliding gasoline consumption tax, particularly in an election year. But it seems that there needs to be some type of national energy policy that will continue to drive down demand for fossil fuels. Perhaps just the discussion of implementing such a tax would be a start.