Knowledge Problem

Nick Schulz from TechCentral Station and Transition Game has an article in today’s National Review Online, in which he discusses gas prices and Kerry’s energy policy suggestions. In addition to referencing yours truly, for which I am exceedingly grateful, he makes a lot of good points about these subjects and how likely Kerry would be to succeed in achieving his proposed policies.

More on OPEC’s new attempt to restrict its production and the federal government reactions, from the New York Times (link courtesy of Megan McArdle), Forbes, and PBS’s Newshour Online.

Many thanks to Virginia Postrel for the link. Note that she observed a reduction in driving in LA in this period of high gas prices. Yes, the demand for gasoline is inelastic, but it’s not vertical/perfectly inelastic!

Note also her post that suggests that it could be 1996 all over again in terms of the oil policy debate. I feel obligated to point out that 1995/6 was when Phase II of the oxygenate/reformulated gasoline regulations under the Clean Air Act Amendments of 1990 were implemented? Coincidence?

I’d also like to hear from John Kerry some more specifics on what he thinks constitutes “normal” gas prices, and how he would propose to keep from having “normal” gas prices as “low” become a political expectation that politicians feel they have to deliver, regardless of the economic inefficiency, environmental implications, and other effects of artificially managed gas prices.

OK, now I have to do some work!

Last night there was an explosion at the third-largest petroleum refinery in the US. Fragmented fuel markets as a result of the patchwork of 40+ fuel formulations in the US to meet federal+state air quality reguations has created an environment in which our refinery industry has little fault tolerance. Put another way, when unexpected stuff goes wrong, because we can’t just substitute more stuff from somewhere else, quantities don’t adjust so prices have to. Thus price spikes.

Let the demagoguery begin! Let it know no bounds, nor be the private purview of either major political party.

One the one hand, John Kerry makes several “proposals” for reducing gas and oil prices, which are of course President Bush’s fault, ably summarized in this Houston Chronicle article. Kerry’s suggestions are laughably unrealistic and unlikely to make a substantial difference in world petroleum markets. The two main suggestions are for the Administration to use moral suasion to persuade OPEC not to reduce output, and for the Administration to discontinue additions to the Strategic Petroleum Reserve. The former is guffaw-producing, the latter is quite literally demagoguing an activity that is a drop in the bucket. Note, though, this Forbes article lists one of his recommendations as reducing the number of fuel formulations to satisfy air quality regulations. So there is a soupcon of sense and substance here, but getting to it through the bluster, pandering and rhetoric is nigh-on impossible.

On the other hand, the Bush Administration argues that had Congress passed an energy bill three years ago, gas prices would be lower today. There is actually a glimmer of substance behind this particular demagoguery, for the reasons Barry Posner laid out last week: all of the energy bill proposals of the past three years would have reduced the number of fuel formulations required in the US to meet air quality regulations. That increase in fungibility of refined product supply would have re-introduced some flexibility into fuel supply. The main drivers of high prices today are crude oil prices and refinery capacit constraints, which are reinforced by the complex and ever-changing regulatory environment. But still, the shrill tone yesterday was one of “don’t blame us, it’s Congress’s fault!”

But in the end, I think Severin Borenstein is right in what he said in an article in the San Jose Mercury News:

“There’s really just not that much that the U.S. president can — or, in my opinion, should — do to pressure OPEC,” said Severin Borenstein, director of the University of California Energy Institute. “It is their oil. They have a right to sell it or not to sell it.”

If the price were adjusted for inflation, a gallon in California still would be cheaper than in 1980: $2.41 in today’s dollars.

And kudos to Laura Kurtzman for noting the real/nominal price distinction in her excellent article!

The SPR injections are a small and cheap insurance policy, an occasionally useful ballast against a cartel with occasional abilities to exercise its market power (that would be OPEC, right now). The SPR has been used in the past to political ends, most recently by President Clinton to reduce domestic gas prices before the 2000 election.

Recall that today is the day that OPEC decides whether or not it will reduce its output. Even after the application of some moral suasion from the US, OPEC has apparently agreed to a cut of 1 million barrels per day. The 800-pound gorilla in the neighborhood, Saudi Arabia, is pushing this because of its domestic budget needs.

If, as OPEC claims, speculative investment funds are driving the increase in world oil prices (I’m not convinced), then some are likely to cash out at these prices. That is one factor that could contribute to a reduction in oil prices.

Another is the extent to which high oil prices induces increased production from non-OPEC suppliers, particularly Russia, Mexico, Norway, and Canada. Most Americans do not realize that our largest oil supplier is Canada. No, not largest after Saudi Arabia — largest, full stop. As my friend Terry Barnich argued at an Illinois-Canada trade conference I attended last Friday, thinking of North America as an integrated energy market and improving oil and natural gas delivery infrastructure (such as pipelines) would enhance our energy trade from our closest neighbors, and reduce OPEC’s market power. That’s a more constructive and concrete recommendation than trying to persuade OPEC to stop; the most persuasive way to make OPEC stop is to stop buying from them. Vote with our dollars instead of whining.

One more potential means of reducing oil prices is the cheating that is inherent in OPEC. Small producers can piggyback on Saudi Arabia’s cut by saying they’ll reduce and then not reducing. That increases their profits with little impact on price. But as prices rise, the temptation to cheat rises too, and as more cheating occurs, it has a larger impact on price. That is the primary dynamic through which cartels are inherently unstable, and through which OPEC has given us boom and bust cycles of oil prices over the past three decades.

A guest post from my colleague Mike Giberson:

In response to your ENOUGH ALREADY ON “RECORD HIGH” GAS PRICES, note that the Washington Post does, on occasion,