Posts tagged ‘gas prices’

This Is Why Freaking Republicans Drive Me Crazy

From the WSJ

A little-noticed provision in a bill passed by the House this month calls for relying more on U.S.-flagged ships to deliver food aid to foreign countries—a change backed by labor groups and criticized by the White House.

The measure, tucked into a Coast Guard and maritime bill, would increase the proportion of food aid transported abroad on private ships flying the U.S. flag, which are required to employ primarily American mariners.

The Obama administration opposes boosting the requirement to 75% of food aid, in tons, from the current 50%, saying it would raise shipping costs by about $75 million a year—siphoning off funds that otherwise could be used to send food aid overseas.

Jeez, when President Obama of all people has to lecture you that protectionism and kowtowing to labor groups is costly, you have gone off the rails.   The Jones Act is one of the stupidest pieces of interventionist legislation on the books and the House should be working on its repeal to sort out the oil transport mess.  Instead, here are the Republicans in the House doubling down on it.  With so-called friends of capitalism doing this garbage, who needs enemies?  At least Progressives trash the economy without pretending that they are pro free market.

By the way, here is a bit from the Cato article on the Jones Act and oil and gas prices

First, the Jones Act - a 94-year-old law that requires all domestic seaborne trade to be shipped on U.S.-crewed, -owned, flagged and manufactured vessels – prevents cost-effective intrastate shipping of crude oil or refined products.  According to Bloomberg, there are only 13 ships that can legally move oil between U.S. ports, and these ships are “booked solid.”  As a result, abundant oil supplies in the Gulf Coast region cannot be shipped to other U.S. states with spare refinery capacity.  And, even when such vessels are available, the Jones Act makes intrastate crude shipping artificially expensive.  According to a 2012 report by the Financial Times, shipping U.S. crude from Texas to Philadelphia cost more than three times as much as shipping the same product on a foreign-flagged vessel to a Canadian refinery, even though the latter route is longer.

It doesn’t take an energy economist to see how the Jones Act’s byzantine protectionism leads to higher prices at the pump for American drivers.  According to one recent estimate, revoking the Jones Act would reduce U.S. gasoline prices by as much as 15 cents per gallon “by increasing the supply of ships able to shuttle the fuel between U.S. ports.”

Some of these costs could potentially be mitigated if it weren’t for the second U.S. trade policy inflating gas prices: restrictions on crude oil exports.  As I wrote for Cato last year, current U.S. law – implemented in the 1970s during a bygone era of energy scarcity and dependence – effectively bans the exportation of U.S. crude oil to any country other than Canada.  Because U.S. and Canadian refinery capacity is finite, America’s newfound energy abundance has led to a glut of domestic oil and caused domestic crude oil prices (West Texas Intermediate and Louisiana Light Sweet) to drop well below their global (Brent) counterpart.  One might think that this price divergence would mean lower U.S. gas prices, but such thinking fails to understand that U.S. gasoline exports may be freely exported, and that gasoline prices are set on global markets based on Brent crude prices.  As a result, several recent analyses – including ones byCitigroup [$], Resources for the Future and the American Petroleum Institute - have found that liberalization of U.S. crude oil exports would lower, not raise, gas prices by as much as 7 cents per gallon.

Phoenix Spent $1.4 Billion To Cannibalize Buses

I have written many times about my problems with Phoenix light rail -- examples are here and here.  We paid $1.4 billion in initial capital costs, plus tens of millions a year in operating losses that must be subsidized by taxpayers, for a line that carries a tiny tiny percentage of Phoenix commuters.  Capital costs equate to something like $75,000 per daily round trip rider  -- If we had simply bought every daily rider a Prius, we would have save a billion dollars.

But, as with most things the government does, it is worse than I thought.  Over the last several years, I have been treating these daily light rail riders as if they are incremental users of the area's transit system.  In fact, they are not, by Valley Metro's (our regional transit authority) own numbers.  Here is the key chart, from their web site.

ridership report chart graphic

Compare 2009 to 2012.  Between those years, light rail ridership increased by just a hair under 8 million.  In the same time period, bus ridership fell by just a hair over 8 million.  So all new light rail ridership is just cannibalizing buses.  We have spent $1.4 billion dollars to shift people to a far more expensive transit platform, which does not offer any faster service along its route (the light rail has to fight through traffic lights on the surface streets same as buses).

This is a pattern seen in most cities that adopt light rail.  Over time, total ridership is flat or falls despite rising rail ridership, because rail is so expensive that it's operation forces transit authorities to cut back on bus service to balance their budgets.  Since the cost per rider is so much higher for light rail than buses, a dollar shifted from buses to light rail results in a net reduction in ridership.

Postscript:  Looking at the chart, light rail has achieved something that Valley Metro has not seen in decades -- a three year period with a decline in total ridership.  Sure, I know there was a recession, but going into the recession the Valley Metro folks were arguing that a poor economy and rising gas prices should boost their ridership.

 

 

Let's Ban Exports of Dow Chemical Products

I have written before that trade policy is generally ALL corporate cronyism -- tariffs or restrictions that benefit a narrow set of producers at the expense of 300 million US consumers.

Mark Perry has yet another example, though with a small twist.  Most corporations are looking for limits on imports of competing products and/or subsidies for their own products exports.  In the case of Dow Chemical, they are looking for limits on exports of key inputs to their plants, specifically oil and natural gas.  CEO Andrew Liveris wants to force an artificial supply glut to drive down his input prices by banning the export (or continuing to ban the export) of natural gas.  If gas producers can't sell their product?  Tough -- let them try to out-crony a massive company like Dow in Washington.

But here is the irony -- there is absolutely nothing in his logic for banning natural gas exports that would not apply equally well to banning the export of his own products.   Like natural gas, his products are all inputs into many other products and manufacturing processes that would all likely benefit from lower prices of Dow's products as Dow would benefit from lower natural gas prices.

So here is my proposal -- any company that publicly advocates for banning exports for its purchases must first have exports of its own products banned.

Another One Bites the Dust

Another solar company which received $2.1 billion in loan guarantees from the Obama Administration has gone bankrupt.  The good news is that it has not spent much of that taxpayer money, and its bankruptcy is probably due more to the bankruptcy of its German parent, which in turn is likely related to the huge cuts Germany has made in its feed-in tariff subsidies.

The big asset possessed by Solar Trust is the Blythe solar project, a planned 1000MW facility that apparently has all of its permitting in place.  The Blythe facility was originally going to be a solar-thermal facility, with adjustable mirrors focusing the sun on a central boiler that would in turn power turbines.   This plan was scrapped last year in favor of a more traditional PV technology, and I know local company First Solar has been hoping to save itself by getting the panel deal (First Solar also has been hammered by the loss of German subsidies).

If we take the cost of this planned 1000MW facility as the stated $2.8 billion (of which 2.1 billion would be guaranteed by US taxpayers), we see the basic problem with solar.   A new 1000MW  natural gas powered electric plant costs no more than about $1 billion.  It produces electricity 24 hours a day.  This solar plant, to be the largest in the world, would produce 1000 MW for only a few hours of the day.  That area of desert gets about 7 peak sun hours per day (the best in the country) so that on a 24 hour basis it only produces 292 MW average.  This gives it a total capital cost per 1000 MW of $9.6 billion, making it approximately 10 times costlier than the natural gas plant to build.  Of course, the solar plant has no fuel costs over time, but solar is never able to close the gap over time, particularly with current very low natural gas prices.

Update:  Apparently the $2.8 billion was just for the initial 484 MW so you can double all the solar costs in the analysis above, making the plant about 20x costlier than a natural gas plant.

One-Program Proof Technocratic Government Does Not Work

Ethanol continues to be one of the dumbest, most costly programs ever engaged in by the Federal government

"Today, about 40 percent of all U.S. corn -- that's 15 percent of global corn production or 5 percent of all global grain -- is diverted into the corn ethanol scam in order to produce the energy equivalent of about 0.6 percent of global oil needs.
Corn prices, now close to $7 per bushel, have more than doubled over the past two years (see chart above). And recent harsh weather, including floods in the Midwest and drought in the South, will likely mean a subpar U.S. corn harvest. That, in turn, will mean yet higher prices for corn, which will translate into higher prices for meat, milk, eggs, cheese and other commodities.
Environmental damage:  check
Fails to meets its goals (of reducing fossil fuel use): check
Raises food prices:  check
Raises gas prices: check
Highly regressive costs that hurt the poor most:  check
Benefits accrue to very a small group of the politically connected:  check

Oil and Speculators

My new column is up at Forbes, and discusses the absurdity of blaming sustained higher oil and gas prices on speculators.

Is there a crime in the current oil prices?  Yes, but it’s not one of speculation.  Prices are a form of communication.  Higher prices tell consumers to use less oil, and producers to go find more.  The real crime today is that while the signal is flashing today to oil companies to go find more crude, the Obama administration has bent over backwards to make such efforts all but impossible.  In fact, the Obama Administration desperately tried and failed to increase oil and gas prices via cap and trade last year.  President Obama is not really against higher oil prices, he just wants them driven higher by the state, not by the markets.

The Silly Oil Speculation Meme

Apparently, the leftish-progressive talking point du jour is that oil speculators  (and wouldn't you know it, those apparently include new libertarian uber-villains the Koch brothers) are artificially raising prices above what a "natural" market clearing price would be.

I have always presumed this to be possible for short periods of time - probably hours, perhaps days.  But if, for any longer period of time, market prices (I am talking here about prices for current oil and immediate delivery, not futures prices) stay above the market clearing price one would normally expect from current supply and demand, then oil has to be building up somewhere.  People would be bending over backwards to sell oil into the market, and customers would be using less.

If futures speculation has somehow unanaturally driven up current prices, where is the oil building up?  I understand the price can go up for future oil, because in futures the inventory is just paper.  But the argument is that futures trading is driving up current oil prices.  When the Hunt brothers tried to corner the silver market, they had to buy and buy and keep buying to sop up the inventory.

Sure, some folks may be storing oil on speculation (and by the way most oil companies are inventorying oil and gasoline this time of year in the annual build up between heating oil season and summer driving season) -- but storing physical oil is really expensive.  And the total capacity to do so incrementally is trivial compared to world daily demand.  A few tanker loads sitting offshore is not going to mean squat (total world crude inventory is something like 350 million barrels at any one time, so adding a million barrels into storage only increases inventory by 0.3% or about.   Another way to look at it is that storing a million barrels of oil represents about 17 minutes of daily demand.   If the price is really being held above the market clearing price, then we are talking about the necessity of buying millions of barrels of oil each and every day and storing them, and to keep doing so day after day after day to keep the price up.  And then once you stop, the price is just going to crash before you can sell it because of the very fact that word got out you are selling it.

I dealt with this in a lot more depth here.  I want to repost it in full.  It's a bit dated (different prices) but still relevant.  Note in particular the irony of my friends point #5 -- this was a real view held by many on the progressive Left.  Ironic, huh?

I had an odd and slightly depressing conversation with a friend the other night.  He is quite intelligent and well-educated, and in business is probably substantially more successful, at least financially, than I.

Somehow we got in a discussion of oil markets, and he seemed to find my position suggesting that oil prices are generally set by supply and demand laughable, so much so he eventually gave up with me as one might give up and change the subject on someone who insists the Apollo moon landings were faked. I found the conversation odd, like having a discussion with a fellow
chemistry PHD and suddenly having them start defending the phlogiston
theory of combustion. His core position, as best I could follow, was this:

  1. Limitations on supply in the US, specifically limitations on new oil field development and refinery construction, are engineered by oil companies attempting to keep prices high.
  2. Oil prices are set at the whim of oil traders in London and New York, who are controlled by US oil companies.  The natural price of oil today should be $30 or $40, but oil traders keep it up at $60.  While players upstream and downstream may have limited market shares, these traders act as a choke point that controls the whole market.  All commodity markets are manipulated, or at least manipulatable, in this manner
  3. Oil supply and demand is nearly perfectly inelastic.
  4. If there really was a supply and demand reason for oil prices to shoot up to $60, then why aren’t we seeing any shortages?
  5. Oil prices only rise when Texas Republicans are in office.  They will fall back to $30 as soon as there is a Democratic president.  On the day oil executives were called to testify in front of the Democratic Congress recently, oil prices fell from $60 to $45 on that day, and then went right back up.

Ignoring the Laws of Economics (Price caps and floors)

While everyone (mostly) knows that we are suspending disbelief when the James Bond villain seems to be violating the laws of physics, there is a large cadre of folks that do believe that our economic overlords can suspend the laws of supply and demand.   As it turns out, these laws cannot be suspended, but they can certainly be ignored.  Individuals who ignore supply and demand in their investment and economic decision making are generally called "bankrupt," at least eventually, so we don’t always hear their stories (the Hunt brothers attempt to corner the silver market is probably the best example I can think of).  However, the US government has provided us with countless examples of actions that ignore economic reality.

The most typical example is in placing price caps.  The most visible example was probably the 1970′s era caps on oil, gasoline, and natural gas prices and later "windfall profit" taxes.  The result was gasoline lines and outright shortages.  With prices suppressed below the market clearing price, demand was higher and supply was lower than they would be in balance.

The my friend raised is different, one where price floors are imposed by industry participants or the government or more likely both working in concert.   The crux of my argument was not that government would shy away from protecting an industry by limiting supply, because they do this all the time. The real problem with the example at hand is that, by the laws of supply and demand, a price floor above the market clearing price should yield a supply glut.  As it turns out, supply guts associated with cartel actions to keep prices high tend to require significant, very visible, and often expensive actions to mitigate.  Consider two examples:

Realtors and their trade group have worked for years to maintain a tight cartel, demanding a 6% or higher agency fee that appears to be increasingly above the market clearing price.  The result of maintaining this price floor has been a huge glut of real estate agents.  The US is swimming in agents.  In an attempt to manage this supply down, realtors have convinced most state governments to institute onerous licensing requirements, with arcane tests written and administered by… the realtor’s trade group.  The tests are hard not because realtors really need to know this stuff, but because they are trying to keep the supply down.   And still the supply is in glut.  Outsiders who try to discount or sell their own home without a realtor (ie, bring even more cheap capacity into the system) are punished ruthlessly with blackballs.  I have moved many times and have had realtors show me over 300 houses — and you know how many For Sale By Owner homes I have been shown?  Zero.  A HUGE amount of effort is expended by the real estate industry to try to keep supply in check, a supply glut caused by holding rates artificially high.

A second example of price floors is in agriculture.  The US Government, for whatever political reasons, maintains price floors in a number of crops.  The result, of course, has been a supply glut in these commodities.  Sopping up this supply glut costs the US taxpayer billions.  In some cases the government pays to keep fields fallow, in others the government buys up extra commodities and either stores them (cheese) or gives them away overseas.  In cases like sugar, the government puts up huge tarriff barriers to imports, otherwise the market would be glutted with overseas suppliers attracted by the artificially high prices.  In fact, most of the current subsidy programs for ethanol, which makes almost zero environmental or energy policy sense, can be thought of as another government program to sop up excess farm commodity supply so the price floor can be maintained.

I guess my point from these examples is not that producers haven’t tried to impose price floors above the market clearing price, because they have.  And it is not even that these floors are not sustainable, because they can be if the government steps in to help with their coercive power and our tax money to back them.  My point is, though, that the laws of supply and demand are not suspended in these cases.  Price floors above the market clearing price lead to supply gluts, which require very extensive, highly visible, and often expensive efforts to manage.  As we turn now to oil markets, we’ll try to see if there is evidence of such actions taking place.

The reasons behind US oil production and refining capacity constraints

As to his first point, that oil companies are conspiring with the government to artificially limit oil production and refining capacity, this certainly would not be unprecedented in industry, as discussed above.  However, any historical study of these issues in the oil industry would make it really hard to reach this conclusion here.  There is a pretty clear documented record of oil companies pushing to explore more areas (ANWR, offshore) that are kept off-limits due to environmental pressures.  While we have trouble imagining the last 30 years without Alaskan oil, the US oil companies had to beg Congress to let them build the pipeline, and the issue was touch and go for a number of years.  The same story holds in refining, where environmental pressure and NIMBY concerns have prevented any new refinery construction since the 1970′s (though after years and years, we may be close in Arizona).  I know people are willing to credit oil companies with just about unlimited levels of Machiavellianism, but it would truly be a PR coup of unprecedented proportions to have maintained such a strong public stance to allow more capacity in the US while at the same time working in the back room for just the opposite.

The real reason this assertion is not credible is that capacity limitations in the US have very clearly worked against the interests of US oil companies.  In production, US companies produce on much better terms from domestic fields than they do when negotiating with totalitarian regimes overseas, and they don’t have to deal with instability issues (e.g. kidnapping in Nigeria) and expropriation concerns.  In refining, US companies have seen their market shares in refined products fall since the 1970s.  This is because when we stopped allowing refinery construction in this country, producing countries like Saudi Arabia went on a building boom.  Today, instead of importing our gasoline as crude to be refined in US refineries, we import gas directly from foreign refineries.  If the government is secretly helping oil companies maintain a refining capacity shortage in this country, someone forgot to tell them they need to raise import duties to keep foreign suppliers from taking their place.

What Oil Traders can and cannot do

As to the power of traders, I certainly believe that if the traders could move oil prices for sustained periods as much as 50% above or below the market clearing price, they would do so if it profited them.  I also think that speculative actions, and even speculative bubbles, can push commodity prices to short-term extremes that are difficult to explain by market fundamentals.  Futures contracts and options, with their built in leverage, allow even smaller players to take market-moving positions.  The question on the table, though, is whether oil traders can maintain oil prices 50% over the market clearing prices for years at a time.  I think not.

What is often forgotten is that companies like Exxon and Shell control something like 4-5% each of world production (and that number is over-stated, since much of their production is as operator for state-owned oil companies who have the real control over production rates).  As a point of comparison, this is roughly the same market Toshiba has in the US computer market and well below Acer’s.  As a result, there is not one player, or even several working in tandem, who hold any real power in crude markets.  Unless one posits, as my friend does, that NY and London traders somehow sit astride a choke point in the world markets.

But here is the real problem with saying that these traders have kept oil prices 50% above the market clearing price for the last 2-3 years:  What do they do with the supply glut?  We know from economics, as well as the historic examples reviewed above, that price floors above the clearing price should result in a supply glut.  Where is all the oil?

Return to the example of when the Hunt’s tried to corner the silver market.  Over six months, they managed to drive the price from the single digits to almost $50 an ounce.  Leverage in futures markets allowed them to control a huge chunk of the available world supply.  But to profit from it (beyond a paper profit) the Hunts either had to take delivery (which they were financially unable to do, as they were already operating form leveraged positions) or find a buyer who accepted $50 as the new "right" price for silver, which they could not.  No one wanted to buy at $50, particularly from the Hunts, since they knew the moment the Hunt’s started selling, the price would crash.  As new supplies poured onto the market at the higher prices, the only way the Hunt’s could keep the price up was to pour hundreds of millions of dollars in to buy up this excess supply.  Eventually, of course, they went bankrupt.  But remember the takeaway:  They only could maintain the artificially higher commodity price as long as they kept buying excess capacity, a leveraged Ponzi game that eventually collapsed.

So how do oil traders’ supposedly pull off this feat of keeping oil prices elevated about the market clearing price?  Well, there is only one way:  It has to be stored, either in tanks or in the ground.  The option of storing the extra supplies in tanks is absurd, especially over a period of years – after all, at its peak, $60 of silver would sit on the tip of my finger, but $60 of oil won’t fit in the trunk of my car.  The world oil storage capacity is orders of magnitude too low.  So the only real option is to store it in the ground, ie don’t allow it to get produced.

How do traders pull this off?  I have no idea.  Despite people’s image, the oil producer’s market is incredibly fragmented.  The biggest companies in the world have less than 5%, and it rapidly steps down from there. It is actually even more fragmented than that, because most oil production is co-owned by royalty holders who get a percentage of the production.  These royalty holders are a very fragmented and independent group, and will complain at the first sign of their operator not producing fast and hard enough when prices are high.  To keep the extra oil off the market, you would have to send signals to a LOT of people.  And it has to be a strong and clear signal, because price is already sending the opposite signal.  The main purpose of price is in its communication value — a $60 price tells producers a lot about what and how much oil should be produced (and by the way tells consumers how careful to be with its use).  To override this signal, with thousands of producers, to achieve exactly the opposite effect being signaled with price, without a single person breaking the pack, is impossible.  Remember our examples and the economics – a sustained effort to keep prices substantially above market clearing prices has to result in visible and extensive efforts to manage excess supply.

Also, the other point that is often forgotten is that private exchanges can only survive when both Sellers AND buyers perceive them to be fair.  Buyers are quickly going to find alternatives to exchanges that are perceived to allow sellers to manipulate oil prices 50% above the market price for years at a time.  Remember, we think of oil sellers as Machiavellian, but oil buyers are big boys too, and are not unsophisticated dupes.  In fact, it was the private silver exchanges, in response to just such pressure, that changed their exchange rules to stop the Hunt family from continuing to try to corner the market.  They knew they needed to maintain the perception of fairness for both sellers and buyers.

Supply and Demand Elasticity

From here, the discussion started becoming, if possible, less grounded in economic reality.  In response to the supply/demand matching issues I raised, he asserted that oil demand and supply are nearly perfectly inelastic.  Well, if both supply and demand are unaffected by price, then I would certainly accept that oil is a very, very different kind of commodity.  But in fact, neither assertion is true, as shown by example here and here. In particular, supply is quite elastic.  As I have written before, there is a very wide range of investments one can make even in an old existing field to stimulate production as prices rise.  And many, many operators are doing so, as evidenced by rig counts, sales at oil field services companies, and even by spam investment pitches arriving in my in box.

I found the statement "if oil prices really belong this high, why have we not seen any shortages" to be particularly depressing.  Can anyone who sat in at least one lecture in economics 101 answer this query?  Of course, the answer is, that we have not seen shortages precisely because prices have risen, fulfilling their supply-demand matching utility, and in the process demonstrating that both supply and demand curves for oil do indeed have a slope.  In fact, shortages (e.g. gas lines or gas stations without gas at all) are typically a result of government-induced breakdowns of the pricing mechanism.  In the 1970′s, oil price controls combined with silly government interventions (such as gas distribution rules**) resulted in awful shortages and long gas lines.  More recently, fear of "price-gouging" legislation in the Katrina aftermath prevented prices from rising as much as they needed to, leading to shortages and inefficient distribution.

Manipulating Oil Prices for Political Benefit

As to manipulating oil or gas prices timed with political events (say an election or Congressional hearings), well, that is a challenge that comes up all the time.  It is possible nearly always to make this claim because there is nearly always a political event going on, so natural volatility in oil markets can always be tied to some concurrent "event."  In this specific case, the drop from $60 to $35 just for a Congressional hearing is not even coincidence, it is urban legend.  No such drop has occurred since prices hit 60, though prices did drop briefly to 50.  (I am no expert, but in this case the pricing pattern seen is fairly common for a commodity that has seen a runup, and then experiences some see-sawing as prices find their level.)

This does not mean that Congressional hearings did not have a hand in helping to drive oil price futures.  Futures traders are constantly checking a variety of tarot cards, and indications of government regulatory activity or legislation is certainly part of it.  While I guess traders purposely driving down oil prices ahead of the hearing to make oil companies look better is one possible explanation;  a more plausible one (short of coincidence, since Congress has hearings on oil and energy about every other month) is that traders might have been anticipating some regulatory outcome in advance of the hearing, that became more less likely once the hearings actually occurred.  *Shrug*  Readers are welcome to make large short bets in advance of future Congressional energy hearings if they really think the former is what is occurring.

As to a relationship between oil prices and the occupant of the White House, that is just political hubris.  As we can see, real oil prices rose during Nixon, fell during Ford, rose during Carter, fell precipitously during Reagan, were flat end to end for Bush 1 (though with a rise in the middle) and flat end to end for Clinton.  I can’t see a pattern.

If Oil Companies Arbitrarily Set Prices, Why Aren’t They Making More Money?

A couple of final thoughts.  First, in these heady days of "windfall" profits, Exxon-Mobil is making a profit margin of about 9% – 10% of sales, which is a pretty average to low industrial profit margin.  So if they really have the power to manipulate oil prices at whim, why aren’t they making more money?  In fact, for the two decades from 1983 to 2002, real oil prices languished at levels that put many smaller oil operators out of business and led to years of layoffs and down sizings at oil companies.  Profit margins even for the larges players was 6-8% of sales, below the average for industrial companies.  In fact, here is the profitability, as a percent of sales, for Exxon-Mobil over the last 5 years:

2006:  10.5%

2005:  9.7%

2004:  8.5%

2003:  8.5%

2002:  5.4%

2001:  7.1%

Before 2001, going back to the early 80′s, Exxon’s profits were a dog.  Over the last five years, the best five years they have had in decades, their return on average assets has been 14.58%, which is probably less than most public utility commissions allow their regulated utilities.  So who had their hand on the pricing throttle through those years, because they sure weren’t doing a very good job!  But if you really want to take these profits away (and in the process nuke all the investment incentives in the industry) you could get yourself a 15 to 20 cent decrease in gas prices.  Don’t spend it all in one place.

** One of the odder and forgotten pieces of legislation during and after the 1972 oil embargo was the law that divided the country into zones (I don’t remember how, by counties perhaps).  It then said that an oil company had to deliver the same proportion of gas to each zone as it did in the prior year  (yes, someone clearly took this right out of directive 10-289).  It seemed that every Representative somehow suspected that oil companies in some other district would mysteriously be hoarding gas to their district’s detriment.  Whatever the reason, the law ignored the fact that use patterns were always changing, but were particularly different during this shortage.  Everyone canceled plans for that long-distance drive to Yellowstone.  The rural interstate gas stations saw demand fall way off.  However, the law forced oil companies to send just as much gas to these stations (proportionally) as they had the prior year.  The result was that rural interstates were awash in gas, while cities had run dry.  Thanks again Congress.

Gas Prices

I find it sort of hilarious that it is Conservatives that are demagoguing gas prices and Liberals who are trying to explain that they really are not that high.  Yet another example of the Coke and Pepsi parties swapping political positions based on whose team is in the White House.

But I thought this graph was interesting, and supports a point I have made for years (Via Flowing Data)

I have worked in oil fields drilling miles below the surface and on offshore platforms in mile-deep water.  I have seen the Alaska pipeline under construction and worked in a 400 thousand barrel a day refinery.  And I can say with confidence that no other product on this list even is in the same order of magnitude as gasoline in terms of the capital investment, effort, and technology that does into delivering a gallon of gas.  The ability to deliver gas for even $4.00 a gallon is almost unbelievable.   Yet no other industry on this list or any other list gets 1/100th the grief oil companies do for being rapacious, greedy, and detrimental to society.

Underestimating the Costs

No, today's post is not on health care, but CO2 abatement.  Marlo Lewis looks at a new Harvard study, and concludes what I have been saying for years -- gas prices are going to have to be forced to $10 or more in this country before we even start making a dent in the Administrations or UN's CO2 abatement targets.   I obviously don't think it is justified based on my views on the climate sensitivity to CO2, but even if it were, let's not pretend it is somehow free.

It's Time to Admit that CO2 Abatement is Going to be Freaking Expensive

I have to tell one of my favorite stories of chutzpah.  In the 1940's and 1950's, railroads were making the transition from steam engines to diesel engines.  One of the changes was that a diesel engine only needed a driver, it did not need a fireman as steam engines did to shovel coal and keep the boiler running well.   The unions of course saw this coming.  So what did they do?  They preemptively made the demand that diesel engines should have to have TWO fireman.  Railroads spent so much time fighting this insane proposal that it took them years to get the firemen per locomotive to the correct number (ie zero).

I am reminded of this story when I think of how the Obama administration has handled the issue of CO2 abatement.  Reasonable people understand that CO2 abatement will be horrifically expensive - it just will not be cheap in terms of cost or lost economic output and lost personal liberties to take the country back to a CO2 per capita it last had in the 19th century.     But rather than taking this on, the Obama administration preemtively attacked, saying that in fact Co2 abatement would lead to economic growth and job creation.  This was the broken windows fallacy on steroids, but the usual progressive illiterates and consumers of party talking points have run with it.

We are finally getting folks to start to address the true costs of CO2 abatement, and they are enormous.  People who push the precautionary principle try to say that even a small risk of climate catastrophe outweighs some minor abatement costs.  But does a small change of manmade warming outweigh a near certainty of enormous economic costs?

I have said for years that to really get to an 80% reduction target, gas prices would have to rise over $20 a gallon  (they are at $10 already in Europe and they are no where near the targets).  Some researchers looked at the gas price implications of more modest CO2 targets:

To meet the Obama administration's targets for cutting greenhouse gas emissions, some researchers say, Americans may have to experience a sobering reality: gas at $7 a gallon.

To reduce carbon dioxide emissions in the transportation sector 14 percent from 2005 levels by 2020, the cost of driving must simply increase, according to a forthcoming report by researchers at Harvard's Belfer Center for Science and International Affairs.

And this is with a straight tax, probably the most efficient way to hit the targets.  The study agreed that other intervenist approaches didn't seem to work as well as a straight tax:

In the modeling, it turned out that issuing tax credits could backfire, while taxes on fuel proved beneficial.

Awesome Takedown of Homeopathy

I have written about it before, but here is Matt Parker:

I have just purchased a packet of Boots-brand 84 arnica homeopathic 30C Pills for £5.09, which Boots proudly claim is only 6.1p per pill. Their in-store advice tells me that arnica is good for treating "bruising and injuries", which gives the impression that this is a very cost-effective health-care option.

Unlike most medication, it didn't list the actual dose of the active ingredient that each pill contains, so I checked the British Homeopathic Association website. On their website it nonchalantly states that to make a homeopathic remedy, they start with the active ingredient and then proceed to dilute it to 1 per cent concentration. Then they dilute that new solution again, so there is now only 0.01 per cent of the original ingredients. For my 30C pills this diluting is repeated thirty times, which means that the arnica is one part in a million billion billion billion billion billion billion.

The arnica is diluted so much that there is only one molecule of it per 7 million billion billion billion billion pills.

It's hard to comprehend numbers that large. If you were to buy that many pills from Boots, it would cost more than the gross domestic product of the UK. It's more than the gross domestic product of the entire world. Since the dawn of civilisation. If every human being since the beginning of time had saved every last penny, denarius and sea-shell, we would still have not saved-up enough to purchase a single arnica molecule from Boots.

The amazing thing to me is that the folks lining up to be fleeced by this industry, and who will vociferously defend that they are not being fleeced, are the types of folks who are typically the first to throw up the barricades in the street when gas prices rise by 5 cents.

By the way, Arizona has a state board of homeopathic examiners to check ... what, exactly?  To guarantee no active ingredient made its way into the product?

Here is a funny related video:

My Climate Plan

From the comments of this post, which wondered why Americans are so opposed to the climate bill when Europeans seem to want even more regulation.  Leaving out the difference in subservience to authority between Europeans and Americans, I wrote this in the comments:

I will just say:   Because it's a bad bill. And not because it is unnecessary, though I would tend to argue that way, but for the same reason that people don't like the health care bill - its a big freaking expensive mess that doesn't even clearly solve the problem it sets out to attack. Somehow, on climate change, the House has crafted a bill that both is expensive, cumbersome, and does little to really reduce CO2 emissions. All it does successfully is subsidize a bunch of questionable schemes whose investors have good lobbyists.

If you really want to pass a bill, toss the mess in the House out. Do this:

  1. Implement a carbon tax on fuels. It would need to be high, probably in the range of dollars and not cents per gallon of gas to achieve kinds of reductions that global warming alarmists think are necessary. This is made palatable by the next step....
  2. Cut payroll taxes by an amount to offset the revenue from #1. Make the whole plan revenue neutral.
  3. Reevaluate tax levels every 4 years, and increase if necessary to hit scientifically determined targets for CO2 production.

Done. Advantages:

  1. no loopholes, no exceptions, no lobbyists, no pork. Keep the legislation under a hundred pages.
  2. Congress lets individuals decide how best to reduce Co2 by steadily increasing the price of carbon. Price signals rather than command and control or bureaucrats do the work. Most liberty-conserving solution
  3. Progressives are happy - one regressive tax increase is offset by reduction of another regressive tax
  4. Unemployed are happy - the cost of employing people goes down
  5. Conservatives are happy - no net tax increase
  6. Climate skeptics are mostly happy -- the cost of the insurance policy against climate change that we suspect is unnecessary is never-the-less made very cheap. I would be willing to accept it on that basis.
  7. You lose the good feelings of having hard CO2 targets, but if there is anything European cap-and-trade experiments have taught, good feelings is all you get. Hard limits are an illusion. Raise the price of carbon based fuels, people will conserve more and seek substitutes.
  8. People will freak at higher gas prices, but if cap and trade is going to work, gas prices must rise by an equal amount. Legislators need to develop a spine and stop trying to hide the tax.
  9. Much, much easier to administer. Already is infrastructure in place to collect fuel excise taxes. The cap and trade bureaucracy would be huge, not to mention the cost to individuals and businesses of a lot of stupid new reporting requirements.
  10. Gore used to back this, before he took on the job of managing billions of investments in carbon trading firms whose net worth depends on a complex and politically manipulable cap and trade and offset schemes rather than a simple carbon tax.

Payroll taxes are basically a sales tax on labor.  I am fairly indifferent in substituting one sales tax for another, and would support this shift, particularly if it heads of much more expensive and dangerous legislation.

Update: Left out plan plank #4:  Streamline regulatory approval process for nuclear reactors.

Update #2: Readers of TJIC wonder if this is effective, calling it just a rebate of the tax.  I answered in the comments as follows:

I think "rebate" is the wrong way to think of it. Of COURSE if you paid a higher price and then had the exactly that amount rebated to you, then it would not be a very powerful incentive. But that is not what is being proposed.

I think things are easier if you consider payroll taxes to be a sales tax on labor, which they are in effect. So we have a sales tax regime, with differing tax levels on different types of products. If we raise taxes on one item, but drop taxes on the others, then sales of that one item are certainly going to suffer. Its price just went up relative to all the other things we buy. Let's imagine a simplified world where we can buy any of 10 items (call them A, B, C, etc), each priced at $10, and we have $100 in income. Now imagine the same world tilted such that we have $105 of income and all items are $10 except "A" which now costs $20 each. On average, most people will buy less "A" and more of other stuff.

I'm a libertarian, so I grit my teeth at such games. I don't like the taxes in the first place. I don't like the government playing outcomes games with taxes. But my point is that if we are going to insist on doing something to limit CO2, then shifting the sales tax burden so that total taxes are the same but taxes on fuels are higher while taxes on labor are lower strikes me as a substantially lower cost solution than any of the other alternatives being suggested.

Universities are Farther Left Than I Remembered

It is not at all surprising that an Ivy League University professor does not recognize a difference between rationing by individual choice based on price signals and rationing based on government mandate.  What is surprising to me is that I remember this particular professor, Uwe Reinhardt, as the only person who would ever take the free market side of campus debates.  Kind of depressing.  I guess he must have seemed free market just by contrast, or else he has evolved a bit.  Is it ironic to anyone else that radicalism of the 1960s, which purported to be based on individualism and freedom, has led to campuses where it is normal not to even consider individual liberty as part of a public policy equation?  It just reinforced my sense that no one really wants to get rid of "the man," they just want to be "the man" themselves.

In particular he writes:

As I read it, the main thrust of the health care reforms espoused by President Obama and his allies in Congress is first of all to reduce rationing on the basis of price and ability to pay in our health system

We actually have plenty of examples of the government ending rationing by price and ability to pay.  Gas price controls in the 1970s are one very good example.  Anyone remember the result?

donovan02

Or more recently in China, where gas prices were controlled well below world market levels:

gaslines

We substituted gas rationing by willingness to pay the posted price with gas price rationing by ability to waste four hours of one's day sitting in lines. (I had never thought of this before, but there must be some interesting economic implications of preferentially routing fuel to those least likely to have a full-time job).

Perhaps worse, Reinhardt equates criticism of the current health care system ( and particularly its productivity) with support for socialization of the system.  Really?  There are perfectly valid free market reasons to criticize health care, where any number of government policy decisions over the years have disrupted the efficacy of price signals and created terrible incentives.

More here from Doug Bandow of Cato

Postscript: Farther left?  Further left?  Sorry, I try, but your scribe is an engineer at heart and sometimes struggles with the native tongue.  When I was in fourth grade, I remember doing a battery of achievement tests, and getting 99+ percentile scores on every test but spelling, where I got something like a 25th percentile.   I think this score put me down mostly with kids for whom English is a second language  (or maybe even worse, with Russian kids for whom ours is a second alphabet).  Only technology in the form of spell-checkers has bailed me out of my personal handicap.

Something that Flabbergasts Me

Since 1972, oil company executives have, like clockwork, been dragged up to Washington every five years to defend themselves against charges that they have cartelized the oil industry with the express purpose of limiting supply and driving up prices to consumers.  Over the last 10 years, and particularly post-Katrina, scrutiny has fallen heavily on US refiners to justify refined product supply shortfalls and resulting price spikes.

So, after years of demagoguing oil companies for purposefully limiting refining capacity and output to drive up gasoline prices, Democrats in Congress are on the verge of passing Waxman-Markey, which will have the very focused and predictable result of... limiting US refining output and driving up gas prices.  In fact, the only possible way it will achieve its goals of limiting CO2 output is if it is wildly successful in reducing gasoline supply and driving up gas prices.  Amazing.

Yet more proor that what is never OK for the [private] goose is always OK for the [public] gander.

Prices Matter

On September 12 last year, I linked an article in the Arizona Republic that I declared to be ridiculous wishful thinking on the part of the author, completely disconnected from how people have responded to price changes in the past:

The worst oil shock since the 1970s has put a permanent mark on the American way of life that even a drop in oil's price below $100 a barrel won't erase.

Public transportation is in. Hummers are out. Frugality is in. Wastefulness is out....

As prices come falling back to earth, Americans aren't expected to drop their newfound frugality. The jarring reality of $4-a-gallon gasoline stirred up an unprecedented level of consumer angst that experts say will keep people from reverting to extravagant energy use for years to come - if ever again....

"I see a permanent shift," said Kit Yarrow, a consumer psychologist at San Francisco's Golden Gate University who has studied how high oil prices have affected Americans' buying behavior. "Historically, when gas prices come down, people use more. But we've learned a lot of new things during this period and it will be hard to go back to our gas-guzzling ways."

Thank God for consumer psychologists.  From the LA Times last week:

Americans have cut back on buying vehicles of all types as the economy continues its slide. But the slowdown has been particularly brutal for hybrids, which use electricity and gasoline as power sources. They were the industry's darling just last summer,  but sales have collapsed as consumers refuse to pay a premium for a fuel-efficient vehicle now that the average price of a gallon of gasoline nationally has slipped below $2.

"When gas prices came down, the priority of buying a hybrid fell off quite quickly," said Wes Brown, a partner at Los Angeles-based market research firm Iceology.

45613269

Prices matter.  Nearly every other form of communication, from advertising to public education to presidential fireside chats to go-green guilt promotion campaigns pale in comparison to the power of prices to affect behavior.

Postscript: I studied a lot of marketing in business school and was a marketing guy for years in corporate America.  I wonder how a marketing guy and a "consumer psychologist" differ?  The only differences I can think of are 1) a marketing guy's pay will suffer over time when he is this wrong and 2) I found in marketing that bringing facts to the table often yielded better forecasts than simply applying my personal biases and wishful thinking.  About 10 seconds of looking at how consumer focus reverted away from conservation after the oil price collapse in the 1980's might have given these guys a hint.   Particularly since the price shock of 2008 was far shorter and less severe than the shocks of the 1970's.  Here is my measure of gas price pain (I have not updated it for the recent price collapse):

gas_prices_2

I Have Been On-Board For A While

I don't think that anthropogenic global warming will be substantial enough to justify massive and expensive interventions to limit Co2.  I won't go into the reasons for this statement, as I have a whole other blog dedicated to climate.  If you are unfamiliar with the arguments that Co2 is likely warming the Earth, but not by nearly as much as alarmists claim, you might start with some of these videos.

However, it seems almost inevitable that the new Congress and Administration will do "something" on Co2, if for no other reason that it has become a self-image issue on the left  (i.e. I am a good person because I care about global warming).  We libertarians are seldom very good at engaging on issues of how such government interventions should be done best.  Every time people ask us our opinion of how to structure such a program to do the least harm, we get about 5 seconds into an answer before we just break down and start yelling, "this is crazy!  Do nothing!  Leave us alone!" (actually, emissions laws are one of the few areas where government regulation helps to protect private property rights).

Bryan Pick at Q&O points to a number of folks advocating an increase in carbon taxes offset by reductions in payroll taxes (Bryan's plan is more comprehensive than this, and is here).  I actually advocated something similar over a year ago.  Here is my logic chain:

  1. The carbon tax is a much, much better approach to reducing CO2 than cap-and-trade systems.  Cap-and-trade is bad for the same reason that politicians like it -- it offers a near infinite playing field for lobbying, special rules, influence-peddling, special exemptions, government chosen winners, etc. while hiding the fact that it is in fact a huge new tax.  My more detailed argument on this can be found here and here and here.
  2. A new carbon tax should be revenue neutral.  After all, the point in the first place is not to raise revenues, but to provide a pricing signal that Americans need to switch away from carbon-based fuels.
  3. A good place to offset revenues is the payroll tax.  Both fuel taxes and payroll taxes are criticized for being regressive, so it is an easy place to try to forge a compromise with the left.  Further, the payroll tax acts effectively as a tax on hiring, so a reduction would certainly be welcome any time, and particularly in a recession.
  4. We need to create a streamlined licensing program for nuclear reactors.  Utilities, particularly ones dependent on coal today, need a realistic option to continue to provide power at reasonable cost in their communities.  Solar and wind are just not reasonable alternatives today.  Nukes are the only carbon-free scalable generating technology we have.

Again, I don't think the dislocations required here are worth the effort, but this is the best way to do it if we must.

Postscript: By the way, here is one thing no one is telling you.  Folks in Congress have tossed around carbon and fuel tax ideas that might add, say 25 cents per gallon.  But if we are truly in thrall to the climate alarmists and take their recommendations, then Co2 outputs must be reduced 50-80% in this country.  We are talking about reducing Co2 output to levels before 1920!  To do this will require a truly massive tax.  Just to scale it, over the last year gas prices doubled by about $2 a gallon, and total miles driven fell by less than 5%.   Europe is at around $8-$9 gas and are nowhere near these climate goals.  I don't think it would be too much to say that gas prices would have to top $20 to reach these goals.

This is why I think the most likely case for climate regulation is that we will have some kind of tax or cap system but that this system will be far short of anything that will really reduce Co2 or even stop its growth.  The costs are just too high, and the benefits too shaky.  You can see that in Europe, as countries back off Kyoto goals  (and even Kyoto goals are far short of what alarmists think we need to be hitting).  And any progress they have made against Kyoto goals has mainly been accidents of changing enconomic and political structures rather than the result of any real targeted action.  What we will get is something that costs a lot without accomplishing much, but will make the left feel better about themselves.  Sound familiar?

Absolutely Predictable

Apparently, even before the first train starts carrying passengers (sometime in December), Phoenix's new light rail system is already forcing bus fares up.  (via a reader)

Before the Valley's light-rail service ever begins, the cost to ride the train and city buses may be headed up.

The issue of raising the Valley's regional fare policy has been brewing for several months as transit officials have struggled to cover
rising gas prices and other increased operation costs, said Greg Jordan, Tempe's transit administrator. Transit and light-rail costs are covered by a half-cent sales tax, which has fallen over the past year.

The real issue is that transit agencies are generally given a fixed pot of money for operating subsidies (in this case the proceeds of a half-cent sales tax) and rail tends to take a hugely disproportionate share of that money, starving out less sexy but more practical and cost-effective bus systems.  Even in the that wet dream of rail planners, Portland:

In fact, 9.8 percent of Portland-area commuters took transit to work before the region build light rail. Today it is just 7.6 percent. In a story repeated in numerous cities that have built rail lines, rail cost overruns forced the city to raise bus fares and reduce bus service. That's a success?

This is even more likely in Phoenix, where buses make far more financial sense than rail, given our very low densities, lack of a real downtown area, and numerous commuting routes.  In fact, not only is it predictable, but I predicted it:

Rail makes zero sense in a city like Phoenix.  All this will do is create a financial black hole into which we shift all of our bus money, so the city will inevitably end up with a worse transportation system, not a better one.  Cities that build light rail almost always experience a reduction in total transit use (even the great God of planners Portland) for just this reason - budgets are limited, so since rail costs so much more per passenger, other transit is cut back.   But the pictures of the train will look pretty in the visitor's guide.

Dumbest Thing I Have Read Today

From the department of wishful thinking comes this:

The worst oil shock since the 1970s has put a permanent mark on the
American way of life that even a drop in oil's price below $100 a
barrel won't erase.

Public transportation is in. Hummers are out. Frugality is in. Wastefulness is out....

As prices come falling back to earth, Americans aren't expected to
drop their newfound frugality. The jarring reality of $4-a-gallon
gasoline stirred up an unprecedented level of consumer angst that
experts say will keep people from reverting to extravagant energy use
for years to come - if ever again.

High gas prices prompted calls to lower speed limits to 55 mph in some states and touched off a seemingly endless wave of "Go Green" campaigns.

"I see a permanent shift," said Kit Yarrow, a consumer psychologist
at San Francisco's Golden Gate University who has studied how high oil
prices have affected Americans' buying behavior. "Historically, when
gas prices come down, people use more. But we've learned a lot of new
things during this period and it will be hard to go back to our
gas-guzzling ways."

Really?  I could have sworn people said that in 1972 and again in 1978.  But the SUV and the Hummer were not even invented until after these oil shocks.  He mentions the 55 mph speed limit, but we once had a national speed limit at 55 in the 1970s and we chucked it.  What possible evidence does this guy have, particularly since the recent shock was not nearly as bad as 1972 or 1978.  In fact, you can see that here in this graph of gas price pain:

Gas_prices_2

And, we have not seen the absolute shortages and gas lines we saw in the 1970s.  Usually these weird statements like this published by the AP are the start of some kind of broader political campaign.  The only thing I can guess is that this is the front end of some leftish/Obama polical message that we need to keep slamming on government conservation directives and alt-energy subsidies even as prices fall.

Oh My God! 40% of Sick Days Taken on Monday or Friday!

I thought this was kind of funny, from the false hysteria department.  The Arizona Republic begins ominously:

If you're already mad about gas prices, prepare to get madder.  Besides paying prices at the pump that were unthinkable a few months
ago, many consumers also are getting ripped off by the pump itself.

Uh, Oh.  I can see it coming.  The AZ Republic has smoked out more evil doings from the oil industry.  I shudder to think what horrors await.

About 9 percent, or about 2,000, of the 20,400 gas pumps inspected this
fiscal year by the Arizona Department of Weights and Measures since
July 1, 2007, failed to pass muster.

Oh my freaking God!  Every fill up, I have a one in 11 chance of my gas being measured wrong.  I just bet those oil companies are coming out in the night to tweak the pump so I get hosed. 

Half of those were malfunctioning to the detriment of customers.

See!  There you go!  Half are to the detriment of customers! 

Oh.  Wait a minute.  Doesn't that mean the other half are to the benefit of customers?  Why would those oil guys be doing that?  This sure isn't a bunch of very smart conspirators.  Could it be that this is just the result of random drift in a measurement device, with the direction of drift equally distributed between "reads high" and "reads low"?

As it turns out, I worked for a very large flow measurement instrument maker for several years.  For a variety of reasons, flow measurement devices can drift or can be mis-calibrated.  To fail the state standard, the meter has to be off about 2.5%, which is about 6 tablespoons to the gallon.  State governments have taken on the task of making sure commercial weights and measures are accurate, and though I think this could be done privately, I don't find it a terribly offensive government task.  Having taken this task on, it is reasonable to question whether it is doing its oversight job well.  But let's not try to turn this into a consumer nightmare by only discussing one half of the normal distribution of outcomes.

Post title stolen from an old Dilbert cartoon.

Economic Impact of Gas Prices

Are gas prices high or low by historical standards?  That seems like a nutty question, with prices at the pump cracking $4.00 a gallon, but one can argue that in terms of household pain, gas prices are nowhere near their historical highs.

Economist Mark Perry, at his blog Carpe Diem, shows that gas prices are far from their highs as a percentage of household income:
Gas

I thought the analysis could be taken one step further.  Mr. Perry was generous enough to send me his data, and I added a fourth piece of data to the analysis:  the average passenger vehicle MPG by year, as reported at the BTS here.  The MPG data set is spotty, and required some interpolation.  Also, data since 2004 is missing, so I assumed 2004 MPG's for more recent years (this is conservative, since the long-term trend would indicate fleet MPG's probably improved since 2004). 

From this data I was able to create what I think is a slightly improved analysis.  The key for households is not how much it costs to buy 1000 gallons, but how much it costs to buy the gas required to drive their typical annual miles.  Using 15,000 as an average driving miles per year per person, we get this result:

Gas_prices_2

So, while I too think paying $4 for gas is not my favorite way to dispose of my income, in terms of average household pain created, gas prices are quite far from their historic highs.

My View on Oil Markets

A number of readers have written me, the gist of the emails being "you have written that X or Y is NOT causing higher oil prices -- what do you think IS causing high oil prices?"  Well, OK, I will take my shot at answering that question.  Note that I have a pretty good understanding of economics but I am not a trained economist, so what follows relates to hard-core economics in the same way pseudo-code relates to C++.

My first thought, even before getting into oil, is that commodity prices can be volatile and go through boom-bust periods.  Here, for example, is a price chart of London copper since 1998:

Copper

While oil prices have gone up by a factor of about four since 1998, copper has gone up by a factor of about 15!  But the media seldom writes about it, because while individual consumers are affected by copper prices, they don't buy the commodity directly, and don't have stores on every street corner with the prices posted on the street.

For a number of years, it is my sense that oil demand has risen faster than supply capacity.  This demand has come from all over -- China gets a lot of the press, but even Europe has seen increases in gasoline use.  Throughout the world, we are on the cusp of something amazing happening - a billion or more people in Asia and South America are emerging from millennia of poverty.  This is good news, but wealthier people use more energy, and thus oil demand has increased.

On the supply side, my sense is that the market has handled demand growth up to a point because for years there was some excess capacity in the system.  The most visible is that OPEC often has been producing below their capacity, with Saudi Arabia as the historic swing producer.  But even in smaller fields in the US, there are always day to day decisions that can affect production and capacity on a micro scale.

One thing that needs to be understood - for any individual field, it is not always accurate to talk about its capacity or even its "reserves" as some fixed number.  How much oil that can be pumped out on any given day, and how much total oil can be pumped out over time, depend a LOT on prices.  For example, well production falls over time as conditions down in the bottom of the hole deteriorate  (think of it like a dredged river getting silted up, though this is a simplification).  Wells need to be reworked over time, or their production will fall.  Just the decision on the timing of this rework can affect capacity in the short term.  Then, of course, there are numerous investments that can be made to extend the life of the field, from water flood to CO2 flood to other more exotic things.  So new capacity can be added in small increments in existing fields.  A great example is the area around Casper, Wyoming, where fields were practically all shut-in in the 1990's with $20 oil but now is booming again.

At some point, though, this capacity is soaked up.  It is at this point that prices can shoot up very rapidly, particularly in a commodity where both supply and demand are relatively inelastic in the short term.

Let's hypothesize that gas prices were to double this afternoon at 3:00PM from $4 to $8.  What happens in the near and long-term to supply and demand?

In the near term, say in a matter of days, little will change on the demand side.  Everyone who drove to work yesterday will probably drive today in the same car -- they have not had time to shop for a new car or investigate bus schedules.  Every merchandise shipper will still be trucking their product as before - after all, there are orders and commitments in place.  People will still be flying - after all, they don't care about fuel prices, they locked their ticket price in months ago. 

However, people who argue that oil and gas demand is inelastic in the medium to long term are just flat wrong.  Already, we are seeing substantial reductions in driving miles in this country due to gas price increases.  Demand for energy saving investments, from Prius's to solar panels, is way up as well, demonstrating that prices are now high enough to drive not only changed behaviors but new investments in energy efficiency.  And while I don't have the data, I am positive that manufacturers around the world have energy efficiency investments prioritized much higher today in their capital budgets.

There are some things that slow this demand response.  Certain investments can just take a long time to play out.  For example, if one were to decide to move closer to work to cut down on driving miles, the process of selling a house and buying a new one is lengthy, and is complicated by softness in the housing markets.  There are also second tier capacity issues that come into play.  Suddenly, for example, lots more people want to buy a Prius, but Toyota only has so much Prius manufacturing capacity.  It will take time for this capacity to increase.  In the mean time, sales growth for these cars may be slower and prices may be higher.  Ditto solar panels. 

Also, there is an interesting issue that many consumers are not yet seeing the full price effects of higher oil and gas prices,and so do not yet have the price incentive to switch behavior.  One example is in air travel.  Airlines are hedged, at least this year, against much of the fuel price increase they have seen.  They are desperately trying not to drive people out of air travel (though DHS is doing its best) and so air fares have not fully reflected fuel price increases.  And since many people buy their tickets in advance, even a fare increase today would not affect flying volumes for a little while.

Another such example that is probably even more important are countries where consumers do not pay world market prices for gas and oil, with prices subsidized by the government (this is mostly true in oil producing countries, where the subsidy is not a cash subsidy but an opportunity cost in terms of lost revenue potential).  China is perhaps the most important example.  As we mentioned earlier, Chinese demand increases have been a large impact on world demand, as illustrated below:

Chinaautos

All of these new consumers, though, are not paying the world market price for gasoline:

While consumers in much of the world have been reeling from spiraling
fuel costs, the Chinese government has kept the retail price of
gasoline at about $2.60 a gallon, up just 9% from January 2007.

During that same period, average gas prices in the U.S. have surged
nearly 80%, to about $4 a gallon. China's price control is great for
people like Tang, who drives long distances in his gas-guzzling Great
Wall sports utility vehicle.

But
Tang and millions of other Chinese are bracing for a big jump in pump
prices. The day of reckoning? Everybody believes it's coming right
after the Summer Olympics in Beijing conclude in late August.

Demand, of course, is going to appear inelastic to price increases if a large number of consumers are not having to pay the price increases.

Similarly, there are factors on the supply side that make response to large price increases relatively slow.  We've already discussed that there are numerous relatively quick investments that can be made to increase oil production from a field, but my sense is that most of these easy things have been done.  Further increases require development of whole new fields or major tertiary recovery investments in existing fields that take time.  Further, we run up against second order capacity issues much like we discussed above with the Prius's.  Currently, just about every offshore rig that could be used for development and exploration is being used, with a backlog of demand.  To some extent, the exploration and development business has to wait for the rig manufacturing business to catch up and increase the total rig capacity.

There are also, of course, structural issues limiting increases in oil supply.  In the west, increases in oil supply are at the mercy of governments that are schizophrenic.  They know their constituents are screaming about high oil prices, but they have committed themselves to CO2 reductions.  They know that their CO2 plans actually require higher, not lower, gas prices, but they don't want the public to understand that.  So they demagogue oil companies for high gas prices, while at the same time restricting increases in oil supply.  As a result, huge oil reserves in the US are off-limits to development, and both the US and Canada are putting up roadblocks to the development of our vast reserves of shale oil.

Outside of the west, most of the oil is controlled by government oil companies that are dominated by incompetence and corruption.  For years, companies like Pemex have been under-investing in their reserves, diverting cash out of the oil fields into social programs to prop up their governments.  The result is capacity that has not been well-developed and institutions that have only limited capability to ramp up the development of their reserves.

One of the questions I get asked a lot is, "Isn't there a good reason for suppliers to hold oil off the market to sustain higher prices?"  Well, let's think about that.

Let's begin with an analogy.  Why wouldn't Wal-mart start to hold certain items off the market to get higher prices?  Because they would be slaughtered, of course.  Many others would step in and fill the void, happy to sell folks whatever they need and taking market share from Wal-mart in the process.  I think we understand this better because we know the players and their motivations better in retail than we do in oil.  But the fact is that Wal-mart arguably has more market power, and in the US, more market share than any individual oil producer has worldwide.  Oil producers have seen boom and bust cycles in oil prices for over a hundred years.  They know from experience that $130 oil today may be $60 oil a year from now.  And thus holding one's oil off the market to try to sustain prices only serves to miss the opportunity to get $130 for one's oil for a while.  People tend to assume that the selfish play is to hold oil off the market to increase prices, but in fact it is just the opposite.  The player who takes this strategy reduces his/her own profit in order to help everyone else. 

This is a classic prisoner's dilemma game.  Let's consider for a moment that we are a large producer with some ability to move prices with our actions but still a minority of the market.  Consider a game with two players, us and everyone else.  Each player can produce 80% of their capacity or 100%.  A grid showing reasonable oil price outcomes from these strategies is shown below:

P1_3

Reductions in our production from 100% to80% of capacity increases market prices, but not by as much as would reductions in production by other producers, who in total have more capacity than we.  Based on these prices, and assuming we have a million barrels a day of production capacity, the total revenue outcomes for us of these four combinations are shown below, in millions of dollars (in each case multiplying the price times 1 million barrels times the percent production of capacity, either 80 or 100%):

P2

We don't know how other producers will behave, but we do know that whatever strategy they take, it is better for us to produce at 100%.  If we really could believe that everyone else will toe the line, then everyone at 80% is better for us than everyone at 100% -- but players do not toe the line, because their individual incentive is always to go to 100% production.  For smaller players who do not have enough volume to move the market individually (but who make up, in total, a lot of the total production) the incentive is even more dramatically skewed to producing the maximum amount.

The net result of all this is that forces are at work to bring down demand and bring supply up, they just take time.  I do think that at some point oil prices will fall back out of the hundreds.  Might this reckoning be pushed backwards a bit by bubble-type speculation?  Sure.  People have an incredible ability to assume that current conditions will last forever.  When oil prices were at $20 for a decade or so, people began acting like they would stay low forever.  With prices rising rapidly, people begin acting like they will continue rising forever.  Its an odd human trait, but a potentially lucrative one for contrarians who have the resources and cojones to bet against the masses and stick with their bet despite the fact that bubbles sometimes keep going up before they come back down.   

I don't have the economic tools to say if such bubble speculation is going on, or what a clearing price for oil might be once demand and supply adjustments really kick in.  I do have history as an imperfect guide.  In 1972 and later in 1978 we had some serious price shocks in oil:

Oilprice1947

Depending on if you date the last run-up in prices from '72 or '78, it took 5-10 years for supply and demand to sort themselves out (including the change in some structural factors, like US pricing regulations) before prices started falling.  We are currently about 6 years into the current oil price run-up, so I think it is reasonable to expect a correction in the next 2-3 years of fairly substantial magnitude. 

Postscript:  I have left out any discussion of the dollar, which has to play into this strongly, because what I understand about monetary policy and currencies wouldn't fill a thimble.  Suffice it to say that a fall in value of the dollar will certainly raise the price, to the US, of oil, but at the same time rising prices of imported oil tends to make the dollar weaker.  I don't know enough to sort out the chicken from the egg here,

My Addiction to Health and Prosperity

Kevin Drum titles a post on providing government incentives for high MPG cars "Ending the Addiction,"  by which I presume he means addiction to gasoline.   I really struggle with the point of view on life that describes consumer affinity for enormously value-producing technologies to be an "addiction."  One could equally well refer to our preference for good health or prosperity to be an "addiction," particularly when fossil fuels have played such a central role in fueling the industrial revolution and the prosperity which it has brought.  With the current jump in oil prices tied so closely to growing wealth in China, never has the tie between fossil fuel use and prosperity been more obvious.

Drum advocates for what he calls a "progressive" proposal:

For cars, the most effective thing would be a "feebate": In the
showroom, less-efficient models would have a corresponding fee, while
the more-efficient ones would get a rebate paid for by the fees. That
way when choosing what model you want you would pay attention to fuel
savings over its whole life, not just the first year or two. It turns
out that the automakers can actually make more money this way because
they will want to get their cars from the fee zone into the rebate zone
by putting in more technology. The technology has a higher profit
margin than the rest of the vehicle.

I will say that this is probably less bad than other "progressive" proposals I have heard, but the logic here is based on consumer ineptness.  Higher gas prices, which drive higher lifecycle costs, are presumably providing exactly this incentive without any government program.  The problem, it seems, is that progressives don't think very much of the common people they wish to defend.  Just as the justification for Social Security is that the average person can't be trusted to make good decisions about their retirement savings so we elites will do it for them, this seems to be the logic here, but even more patronizing.   Here is the best bit which really demonstrates the point I am making:

Here's a further suggestion: require stickers to list the estimated cost of fuel consumption over a five year period.

Basically this calculation is total estimated miles per year divided by mpg times estimated gas prices times five. A simple piece of math with four numbers that can be completed on a calculator in 10 seconds or by hand in less than 30 seconds.  Mr. Drum, a big supporter of our current monopoly government school system, apparently does not think that people educated in this system can do this math for themselves.  Could it be clearer that "progressivism" is really about disdain for the common man and a belief that elites should make even the smallest decisions for them?

The Oil Prices We Deserve

A good column on gas prices by George Will.

Can a senator, with so many things on his mind, know so precisely how
the price of gasoline would respond to that increase in the oil supply?
Schumer does know that if you increase the supply of something, the
price of it probably will fall. That is why he and 96 other senators
recently voted to increase the supply of oil on the market by stopping
the flow of oil into the Strategic Petroleum Reserve,
which protects against major physical interruptions. Seventy-one of the
97 senators who voted to stop filling the reserve also oppose drilling
in the Arctic National Wildlife Refuge.

One million barrels is what might today be flowing from ANWR if in 1995 President Bill Clinton
had not vetoed legislation to permit drilling there. One million
barrels produce 27 million gallons of gasoline and diesel fuel.
Seventy-two of today's senators -- including Schumer, of course, and 38
other Democrats, including Barack Obama, and 33 Republicans, including John McCain -- have voted to keep ANWR's estimated 10.4 billion barrels of oil off the market.

Prices vs. Government Action

Very often on this blog I criticize some ill-conceived government intervention as being bloated and/or ineffective and ill-conceived.  A great example is corn-ethanol, where the government has spent billions and caused consumers to spend additional billions in higher food and gas prices, all for a technology that does nothing to reduce oil consumption or CO2 output.

Too often, I criticize these programs for being stupid and ill-conceived, which they are.  But what I don't take the time to also point out is the necessarily narrow focus of these government actions.  No matter how hard Congress works to stuff energy and farm bills with every micro-managing pork barrel project their campaign donors could wish for, Congress still only has the bandwidth to affect a tiny fraction of a percent of what a single change in market prices can achieve.  Prices have absolutely stunning power of communication.  When gas prices go up, every single citizen likely reassesses his/her behavior and spending in a myriad of ways.  Thousands of entrepreneurs sit at their desk staring at the walls, trying to dream up business opportunities that these new prices may signal.  And thousands of energy producers, from the tiniest to the largest, rethink their investment plans and priorities. 

Where is the Windfall Profits Tax on Farmers?

This week, we have been given a chance to see a real contrast.  Two consumer staples, gasoline and food, have both seen their prices go up substantially over the last several months.  Both price spikes have been due to a combination of market forces (particularly increasing wealth in Asia) and US government policy that has the effect of restricting supply.

However, the political response from Congress has been completely different.  In the very same week that Democrats in Congress have introduced bills to punish oil companies for high prices with windfall profits taxes, they have passed a farm bill that rewards farmers who are already getting record high prices with increased price supports and direct subsidies.  This despite the fact that on a percentage basis, the increase in crop prices has been far larger than the recent increase in gas prices.  The contrast in approaches to two industries in very similar situations couldn't be more stark.

The only reason I can come up with is votes:  There are a lot more farmers and people who feel themselves dependent on the agricultural industry than there are oil workers.  The oil industry is incredibly efficient on a revenue per employee basis, and I guess that comes back to haunt them.  There is no oil industry equivalent of the Iowa Caucuses to cause politicians to fall to the ground groveling and shoveling out taxpayer money to buy votes.