Here’s Your Daily Gas And Oil Update

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.”

Borenstein also said diverting oil from the strategic reserve would not have much of an effect, because the amount that goes into the reserve each day is too small to affect the U.S. market.

Gas prices may seem high to consumers now, but that is largely because they have been relatively low in recent years. Considered over 30 years — since the 1973 OPEC embargo — today’s pump prices are about average, Borenstein said.

According to the AAA, the average price of a gallon of regular gasoline Tuesday was $1.75, a record. In California, it was $2.13, a nickel less than the March 6 record.

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.


5 thoughts on “Here’s Your Daily Gas And Oil Update

  1. Good article.

    It is indeed interesting to see the partisan bickering over what is basically a market phenomenon arguably brought on by government meddling; both foreign and domestic.

    You mention Canada’s huge reserves (equivalent to Iraq from what I have read). Realize that much of that is bitumen, so-called “oil sands”. The infrastructure for significantly exploiting this resource is only now starting to come on line and will only be a significant player years downstream. Much will be needed in the interim by way of infrastructure engineering development to fully utilize that resource.

    BTW, I am visiting you via Instalanche. 🙂

  2. “the most persuasive way to make OPEC stop is to stop buying from them. Vote with our dollars instead of whining.”

    Why would this work? OPEC will sell to the rest of the world, we’ll buy from Canada, and the prevailing price won’t change a bit. Whether we buy from Canada or Saudi Arabia, the price is determined by global supply. I don’t see how buying from Canada changes that.

  3. (This is in reference to Jamie’s comment.) I took a look at the statistical correlation between gas prices in Los Angeles and its the returns from several oil-related stocks. I couldn’t find any statistical significance. (Most people would assume that stock price is a proxy for expectations of earnings.) Take a look, and tell me if I did anything wrong. http://www.borlik.net/blog/archives/000089.html.

  4. Jeff,

    Nice work as far as it goes. You might sharpen the point some if you throw in a few more companies that sell significant quatities of gasoline in CA. Try Arco, Shell, Unocal and Texaco. BP is pretty much a non-participant in CA. Exxon includes Mobil and they are definitely a major player here.

    A problem affecting any correlation numbers for any of these companies is that they all operate in a lot of states in addition to CA. That will tend to mask any CA-peculiar effects.

    Because of CA-specific formulation regs, price rises tend to be sharper here than in most of the rest of the nation. CA gas can be sold elsewhere, but the reverse is not true. This means the CA market is more supply-constrained as a baseline condition than most other places.

    I would take out Halliburton. Its connection to the oil industry is as a services provider on the production side, but it doesn’t get paid based on production or crude price and I don’t think it has any significant interests in refining and distribution. Also, it has significant revenue that is not related to oil production, which just muddies the waters further.

    Jamie,

    It’s tough to comment with precision on stuff that isn’t linked to. It’d be nice if Sen. Levin’s staffers would include original materials and not just summaries colored by obvious political spin.

    Still, a few things stand out if only for their patent idiocy.

    I notice, for example, that just-in-time (JIT) production is treated as though it’s some kind of sinister corporate plot to screw the consumer by creating artificial shortages – at least when oil companies do it. In point of fact, JIT is pretty much standard practice in every industry today. I can just imagine the reaction Sen. Levin would get if he tried selling that “JIT is evil” line to his contributors in the auto industry. JIT is one of the important reasons that almost everything we buy is cheaper, in inflation-adjusted terms – than it was 10, 20 and 30 years ago. That includes cars. If Detroit hadn’t gotten serious about cutting its inefficiencies, there wouldn’t BE any auto companies left in Michigan by now, and no executives from same to be writing Sen. Levin all those fat checks.

    That thing about cutting back production of gasoline with oxygenates is weird too. From the little snippet in the document, I can’t really tell either what is being alleged or what its alleged effects are. There is certainly no obvious relationship between cutting oxygenated gas production and higher prices or profits.

    One thing you might notice about all of the alleged “schemes” purported is that none of them is said to be good for pushing up the gas price more than a cent or two. Even if all of them were done together – and assuming no inconsistencies or trade-offs exist among them – you’re talking MAYBE a dime or so a gallon. When gasoline goes from $1.50/gal. to $2.25 like it has in CA over the past few months, the reason is market forces, not sinister conspiracies.

    In point of fact, global demand for gasoline is up. The Chinese are trading their bikes for cars and they aren’t in much better energy-independence condition than we are. Chinese car ownership is increasing at a 40% annual rate. This situation is NOT gonna get better. They’re gonna keep motorizing no matter WHO is President of the U.S. Mr. Bush can’t do anything about it and neither can Mr. Kerry. Personally, I’m not making any plans that depend on gas EVER going back below $2.00/gal. I’d advise you to do the same. In five years we’ll all probably think these are “the good old days.”

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