Category Archive for: Oil [Return to Main]

Tuesday, June 06, 2006

Refining Monopoly Power

As the demand for gasoline has grown, why hasn't refining capacity expanded at a faster rate, and how can the rate be increased in the future?:

Pumped Up, by James Surowiecki, The New Yorker: At first glance, there’s nothing unusual about the refinery that Marathon Oil owns in Garyville, Louisiana. ... Indeed, the only thing that’s special about the Garyville facility is that it was opened in 1976. That makes it the last refinery ever built in the United States.

Until recently, this didn’t seem like a problem. Gasoline was cheap, and no one was clamoring to live next to a highly combustible chemical plant. So, over the past twenty-five years, the number of refineries in the U.S. has been cut in half, and although the remaining ones have expanded, they haven’t kept up with the growing demand for gasoline. But now, with voters furious about three-dollar-a-gallon gas, Washington has decided that this trend must change. Samuel Bodman, the Energy Secretary, has exhorted oil companies to use some of their hefty profits to expand refining capacity, and Congress is considering streamlining the environmental regulations that add to the expense of building new refineries...

There are so few refineries in the U.S. now that they are run tight to the bone, typically using about ninety per cent of their total capacity. The result is that refining—which, until recently, was a tough, low-margin business—has become tremendously lucrative. Last year, refiners’ profits jumped thirty-nine per cent, to twenty-four billion dollars, and this year should be even better...

In a normal marketplace, of course, high prices and profits would drive companies to expand, in an attempt to capture more of the market, or else new players would emerge, hoping to outmaneuver a risk-averse establishment. But the refining industry isn’t a normal marketplace. For one thing, refineries are huge investments—a new one costs at least two billion dollars—and they take a long time to open. This means that although refiners might make more money by opening new facilities and thus serving more customers, they’d rather take the sure money than gamble. It also means it’s hard for new competitors to raise enough capital to enter the market at all.

What’s more, over the past fifteen years refiners have been buying each other up, creating an industry that’s highly consolidated. In 1993, the five biggest refiners in the U.S. controlled thirty-five per cent of the market. By 2004, they controlled fifty-six per cent. And refining is primarily a regional business. The government allows different states to use different formulations of gasoline—some formulations burn cleaner than others—and in some urban areas a federal requirement determines what formula can be used, depending on the quality of their air. That makes it hard to ship gas across state lines, and shrinks the number of refiners that provide a particular blend of gas, giving each refiner more power. As a result, in many areas the refinery business is more like an oligopoly than like a competitive market. In 2002, a Senate report identified “tight oligopolies” operating in twenty-eight states; in California in 2003, ninety-five per cent of the refining market was in the hands of just seven companies. ...

Some have suggested that the lack of new refineries points to collusion on the part of refiners—an agreement to reduce capacity... But in refining today there’s no need for a cartel; the investment decisions that the companies make have such a direct impact on prices that it’s rational for each of them individually to limit capacity.

And if Washington wants a scapegoat it might take a look at itself. By not vetting mergers more carefully, government regulators allowed many refiners to achieve “market power”..., and other regulators enhanced that power by mandating gasoline standards without considering competition...

In general, monopoly power is associated with prices that are too high and a level of production that is too low relative to the competitive or socially optimal outcome. In competitive markets, when price is above the cost of production, the resulting profit attracts new capacity to the industry, but when monopoly power exists this mechanism breaks down.

Policymakers should take steps to make these "tight oligopolies" more competitive as a means of encouraging additional investment and lower prices before considering tax cuts, the easing of environmental restrictions, and other government incentives that increase profit with no guarantee of subsequent increases in refining capacity.

In addition, reductions in the demand for gasoline through conservation and other programs can also reduce the need for additional capacity and this is an area that has not received enough attention from policymakers (see Feldstein's proposal for tradeable gas credits for one idea).

Sorry for the outburst of supposedly conservative values, advocating competitive markets and all that, but somebody has to do it and besides, as I've argued before conservatives do not have a monopoly on this idea. Democrats are also strong advocates of well-functioning markets.

Monday, June 05, 2006

Tradeable Gas Rights

Martin Feldstein has a way to reduce gasoline consumption, tradeable gas rights:

Tradeable Gasoline Rights, by Martin Feldstein, Commentary, WSJ: The rapid rise in the price of gasoline has produced calls for tougher fuel economy standards on new cars and trucks. Although reduced gasoline consumption would be good for the environment and for national security, such a regulatory change would be a mistake. A far better approach would be a system of tradeable gasoline rights, or TGRs. These could be distributed in a way that actually raises the income of a majority of households while giving everyone an incentive to reduce gasoline consumption.

In a system of tradeable gasoline rights, the government would give each adult a TGR debit card. The gasoline pumps at service stations ... would be modified to read these new TGR debit cards... Buying a gallon of gasoline would require using up one tradeable gasoline right as well as paying money.

The government would decide how many gallons of gasoline should be consumed per year and would give out that total number of TGRs. In 2006, Americans will buy about 110 billion gallons of gasoline. To keep that total unchanged in 2007, the government would distribute 110 billion TGRs. To reduce total gasoline consumption by 5%, it would cut the number of TGRs to 104.5 billion.

The government could distribute TGRs to reflect geographic differences in driving patterns. ... Businesses that use trucks would also get TGRs.

A key feature of these gasoline rights is that they are tradeable. Individuals with more TGRs than they need could sell the excess, while those who want to use more gallons than their allocation would have to buy extra TGRs. The gasoline companies could act as clearing houses for these trades, using their gasoline pumps to sell TGRs in the same way that they sell gasoline or to buy TGRs in exchange for the cash needed to purchase gasoline. Other institutions like banks could also trade TGRs for cash. And individuals could of course buy and sell TGRs among themselves by letting others use their card.

The market price of a TGR would depend on the number of TGRs that the government distributed relative to the number of gallons that households would buy if there were no TGR system. The smaller the number of TGRs, the greater would be the price per TGR... The money price of gasoline would continue to reflect the world price of oil and the local cost of refining and distribution.

If the price of a TGR turned out to be 50 cents, an individual who buys an extra 20 gallons of gasoline would use up $10 worth of TGRs. If he avoids the purchase -- by driving less, driving at speeds that use less gas, or driving a more fuel-efficient car -- he could sell the 20 TGRs for $10.

The 50 cent price of the TGR would have the same incentive effect as a 50 cent gasoline tax. But while a gasoline tax lowers everyone's real income, the TGR system creates winners as well as losers. Someone who receives 800 TGRs for a year but only needs 500 would pocket $150 by selling his unwanted TGRs. But even such individuals would still face the right incentive: Every extra gallon consumed would reduce their net cash by 50 cents.

Advocates of a gasoline tax argue that it would produce extra revenue that could be used to reduce the budget deficit or to finance equally large cuts in personal taxes. ... [But] it is hard to believe that Congress would now respond to the public's unhappiness over high gasoline prices by enacting a gasoline tax that would raise the price even more.

That aversion to a higher gasoline tax is why tougher mileage standards for new cars is back on the legislative table. They would, however, do virtually nothing to lower the price of gasoline. And if individuals want to economize on gasoline by driving smaller or more fuel-efficient cars, they can do so now without government action. ...

Higher gas mileage standards would reduce gasoline demand in a very inefficient way by focusing exclusively on the rated mileage of new cars. Separate fuel efficiency standards for each type of vehicle -- one of the options now being considered -- would be even worse because it would provide no incentive to switch to more fuel-efficient cars.

Requiring higher mileage standards on new cars would do very little to reduce total gasoline consumption in the near term because each year's new cars are only about 10% of the total cars on the road. Unlike the system of TGRs that raises the effective cost per gallon, the new car standard would do nothing to change the behavior of owners of existing cars. But the TGR system would cause owners to economize on gasoline by driving fewer miles, driving at speeds that use less gasoline, using tires that improve miles per gallon, and servicing their engines to maintain fuel efficiency. And of course the higher effective cost of gasoline would also cause new car buyers to prefer more fuel-efficient vehicles.

In short, a system of tradeable gasoline rights would be better than either higher taxes or tougher new car regulations. That a majority of households could benefit from the TGR system while all households would have an increased incentive to economize on gasoline is both an economic and a political advantage. It would be an efficient way to reduce gasoline that Congress could actually pass.

Getting over my surprise at the Feldstein's call for government intervention in the marketplace, particularly for the government to set a national cap, I'm not fully convinced. Would the cap on gasoline usage be as easy to lift as the debt limit?

In addition, while this proposal does provide the correct incentive at the margin, I can envision an endless political fight over the allocation of credits. Should LA residents get more credits than NY or SF in the zero-sum allocation? Will cities or regions with more credits per person relative to average distance traveled see people moving in to take advantage of the chance to earn extra income? If I don't own a car, am I out of luck? Is it per person as in Feldstein's proposal, or will it be changed to per household? Do households with more kids get more coupons? Will rural residents get more credits? If so, how much more? Over time, will the credits per person be decided based upon political considerations rather than economics? This may well be better than other proposals in a lot of dimensions and I am not opposed to it, but unless I missed something on the allocation part, it doesn't seem so obvious that it would sail through congress. [Update: More at Brad Delong and Angry Bear]

Sunday, June 04, 2006

Oil Prices and the Canadian Dollar

Stephen Gordon reports on a 'plausible' reason for the apparent structural break in the relationship between the US dollar-Canadian dollar exchange rate and oil prices around 1993:

Worthwhile Canadian Initiative: Oil prices and the Canadian dollar: A mystery solved: In an earlier post, I noted that the relationship between the CAD-USD exchange rate and oil prices hasn't always strong as it has apparently been over the past few years. Since I hadn't been able to sort this problem out on my own, I went into last weekend's session on this topic organised by the Bank of Canada at the meetings of the Canadian Economics Association with a certain amount of the hope. Happily, I wasn't disappointed.

The story starts with Bob Amano and Simon van Norden's paper written in the early 1990's, in which they found that an increases in the price of oil prices were generally associated with depreciations in the value Canadian dollar. Unsurprisingly, the Bank of Canada has found this to be a less-than-spectacularly-successful forecasting model over the past few years, so they've been taking a second look.

Robert Lafrance's (et al) paper suggests a structural break in the relationship between oil prices and the exchange rate sometime around 1993. Sure enough, when you go to the data, the correlation coefficient between the WTI oil price (divided by the US GDP deflator) and the CAD is -0.69 before 1993, and 0.71 afterwards. Why?

The third paper of the session, given by the IMF's Tamim Bayoumi, suggests a plausible explanation. Instead of using oil prices as an independent variable, they use the value of net oil exports, and their model tracks the last few years quite well. Here's a graph of the real value of net oil exports and oil prices:

Click on figure to enlarge

Ordinarily, we'd expect that a rise in oil prices would increase the value of net oil exports, thus leading to an appreciation of of the CAD. And if you look at the data since 1993, that story seems to be consistent with what we observed.

But the story from the 1970s and 1980s is very different. The rise in oil prices during the 1970s was associated with a reduction in the value of net oil exports, so it's not surprising that an econometric model that used data from this period would pick up that negative relationship.

After this was pointed out, the general consensus of those who were at the  session seemed to be that the experience of the 1970s and 80s was explained by the dirigiste oil policies of the era; the reaction of the governments of the day to the increase in oil prices was to reduce exports in order the ensure 'secure' oil supplies for the domestic market. So even though oil prices were increasing, net exports of oil went negative, thus putting downward pressure on the CAD.

Once oil production and trade had been liberalised (and especially after NAFTA), the correlation between the CAD and oil prices went back to being positive.

Saturday, June 03, 2006

Friedman: A Quick Fix for the Gas Addicts

Thomas Friedman comes out from behind New York Times paywall:

GM keeps the gas flowing and U.S. soldiers in danger, By Thomas L. Friedman, [FREE link] [NY Times link]: Is there a company more dangerous to America's future than General Motors? Surely, the sooner this company gets taken over by Toyota, the better off our country will be.

Why? Like a crack dealer looking to keep his addicts on a tight leash, GM announced its "fuel price protection program" on May 23. If you live in Florida or California and buy certain GM vehicles by July 5, the company will guarantee you gasoline at a cap price of $1.99 a gallon for one year — with no limit on mileage. Guzzle away.  ...

"This program gives consumers an opportunity to experience the highly fuel-efficient vehicles GM has to offer in the midsize segment," Dave Borchelt, GM's southeast general manager, said in the company's official statement. Oh, really?

Eligible vehicles in California include the 2006 and 2007 Chevrolet Tahoe and Suburban (half-ton models only), ... GMC Yukon and Yukon XL SUVs (half-ton models only), Hummer H2 and H3 SUVs, ...

Let's see, the 6,400-pound Hummer H2 averages around nine miles per gallon. It really is great that GM is giving more Americans the opportunity to experience nine-miles-per-gallon driving. And the hulking Chevy Suburban gets around 15 miles per gallon. It will be wonderful if more Americans can experience that, too...

Our military is in a war on terrorism in Iraq and Afghanistan with an enemy who is fueled by our gasoline purchases. So we are financing both sides in the war on terror. And what are we doing about that? Not only is GM subsidizing its gas-guzzlers, but not a single member of Congress, liberal or conservative, will stand up and demand what most of them know: that we must have some kind of gasoline tax to compel Americans to buy more fuel-efficient vehicles and to compel Detroit to make them.

Where are the presidential aspirants on this issue? ... [I]f you go to GM's Web site, you will see an ad with a young African-American boy saluting an American flag, above the following offer for U.S. military personnel: "In appreciation of your commitment to our country, GM extends a $500 exclusive offer to active duty military and reserves when you purchase or lease select 2005, 2006 or 2007 GM cars, trucks and SUVs — just show your military ID!"

That's really touching. First GM offers a gasoline subsidy so more Americans can get hooked on nine-mile-per-gallon Hummers, and then it offers a discount to the soldiers who have to protect the oil lines to keep GM's gas guzzlers guzzling. Here's a rule of thumb: The more Hummers we have on the road in America, the more military Humvees we will need in the Middle East.

You want to do something patriotic, GM, Ford and Daimler-Chrysler? Why don't you stop using your diminishing pools of cash to buy votes so Congress will never impose improved mileage standards? That kind of strategy is why Toyota today is worth $198.9 billion and GM $15.8 billion. GM is worth just slightly more than Harley-Davidson, the motorcycle company ($13.6 billion).

President Bush remarked the other day how agonizingly tough it is for a president to send young Americans to war. Yet, he's ready to do that, but he's not ready to look Detroit or Congress in the eye and demand that we put in place the fuel-efficiency legislation that will weaken the forces of theocracy and autocracy that are killing our soldiers in Iraq and Afghanistan — because it might cost Republicans votes or campaign contributions...

Friday, May 26, 2006

Krugman: Nuclear Energy Should Not Be the Main Answer to Our Energy Problems

Paul Krugman responds to comments on his latest column and gives sources for his estimates of the cost of policies to offset global warming:

Krugman's Money Talks: Al Gore and the Future of Energy, Commentary, NY Times: Readers respond to Paul Krugman's May 26 column, "A Test of Our Character "

...William R. Mosby, Salt Lake City: Does nuclear energy have a part to play in mitigating global warming in the long term? ... [T]hose who see an urgent need to do something about global warming generally don't talk about nuclear energy as a prominent part of the solution. Do they think that nuclear energy would be a bigger problem than global warming?

Paul Krugman: I was at a reception for Al Gore after a screening of his movie, and he was asked that very question. I thought his answer was very good. He said that yes, nuclear should be part of the mix, but it can't be the main answer. And there are problems with nuclear we need to resolve: not just disposal of radioactive waste, but vulnerability to terrorist attack. In fact, as nuclear power becomes more common around the world, the possible misuse for weapons, terrorist or otherwise, will be a big problem. So unless there are some breakthroughs, nuclear power is only a piece, and maybe not a big one, of the solution.

Mark Neely, Santa Monica, Calif.: ...Is there a way to calculate the profit oil companies make relative to the price of a barrel of crude? ... I ask because it seems to me that all administration energy policies seem to encourage diminishing the availability of crude outside the Arctic Circle and U.S. coastlines at any rate. This only makes sense to me if profitability increases for the oil companies when the price of crude goes up and if, as seems obvious, the administration is facilitating the profitability of oil companies at the expense of the public good.

Paul Krugman: It's not that simple. It depends on what the oil company does. To some extent, oil companies own crude production, and in that case they make more money when the price of crude rises. But a lot of what they do is refining, and the profits on refining depend on the "crack spread" — the difference between the price of a barrel of crude and the price of the gasoline, fuel oil, and other stuff you make from that barrel. Right now both the price of crude and the crack spread are very high, so oil companies are making huge profits.

Michael Papenfus, Milwaukee, Wisc.: ...If you have them available, can you recommend a few citations of serious economic studies exploring the costs of reducing CO2 emissions?

Paul Krugman: Some correspondents have asked for sources on the costs of policies against global warming. It's all pretty technical stuff, but here are two things I looked at. (An awful lot of work goes into things that never make it into the column!) First, in 1998, the Energy Information Agency (a part of the Energy Department) did a survey on the costs of complying with the Kyoto treaty, back before Bush rejected the whole thing. The executive summary is at Basically, EIA found that trying to meet the Kyoto target on emissions by 2010 might be fairly expensive, but that meeting the target by 2020 wasn't. The report also compared a number of other estimates:

Second, William Cline of the Institute for International Economics did a study of climate change policy, which can be found here (pdf), and gives very long-run analyses. I'd focus on Figure 7, on page 21: the costs of an aggressive anti-warming policy eventually reduce Gross World Product by about two percent, compared with what it would otherwise be, but only over a very long period.

Monday, May 22, 2006

Oil, Religion, and Debt

An email (thank you) says to take a look at this review of Kevin Phillip's book outlining three perils facing the U.S., oil, religion, and debt:

The US in Peril?, by Jeff Madrick, The New York Review of Books, June 8, 2006: Review of  American Theocracy: The Peril and Politics of Radical Religion, Oil, and Borrowed Money in the 21st Century, by Kevin Phillips:

1. ...In Kevin Phillips's view, the Bush energy policy is a prime example of America's failure to confront its most difficult challenges. Phillips, once a member of the Nixon administration, ... argues that America is very different from the independent and omnipotent nation portrayed by President Bush and his administration. Dependency on oil is one of three major tendencies that will seriously undermine America's future, he writes, the other two being the influence of radical religion and the growing reliance on debt to support the economy. For Phillips, these constitute "the three major perils to the United States of the twenty-first century," and he offers little hope that the US will avoid the consequences...

Continue reading "Oil, Religion, and Debt" »

Friday, May 12, 2006

Paul Krugman: Gas Tax Follies

Staying with the topic of the previous post, oil policy, when George Bush was a candidate for president in 2000, he proposed a reduction in gasoline taxes as a solution to high gasoline prices, and similar calls have been heard at the federal level. Many states are currently entertaining serious proposals to reduce gasoline taxes as well, at least temporarily. Here's a rerun of Paul Krugman's March 15, 2000 column evaluating Bush's proposal to lower gasoline taxes, an analysis that is equally applicable today:

Gasoline Tax Follies, by Paul Krugman, Commentary, New York Times, March 15, 2000: Teachers of economics cherish bad policies. For example, if New York ever ends rent control, we will lose a prime example of what happens when you try to defy the law of supply and demand. And so we should always be thankful when an important politician makes a really bad policy proposal.

Last week George W. Bush graciously obliged, by advocating a reduction in gasoline taxes to offset the current spike in prices. This proposal is a perfect illustration of why we need economic analysis to figure out the true "incidence" of taxes: the people who really pay for a tax increase, or benefit from a tax cut, are often not those who literally fork over the cash. In this case, cutting gasoline taxes would do little if anything to reduce the price motorists pay at the pump. It would, however, provide a windfall both to U.S. oil refiners and to the Organization of Petroleum Exporting Countries.

Let's start with why the oil cartel should love this proposal. Put yourself in the position of an OPEC minister: What sets the limits to how high you want to push oil prices? The answer is that you are afraid that too high a price will lead people to use less gasoline, heating oil and so on, cutting into your exports. Suppose, however, that you can count on the U.S. government to reduce gasoline taxes whenever the price of crude oil rises. Then Americans are less likely to reduce their oil consumption if you conspire to drive prices up -- which makes such a conspiracy a considerably more attractive proposition.

Anyway, in the short run -- and what we have right now is a short-run gasoline shortage -- cutting gas taxes probably won't even temporarily reduce prices at the pump. The quantity of oil available for U.S. consumption over the near future is pretty much a fixed number: the inventories on hand plus the supplies already en route from the Middle East. Even if OPEC increases its output next month, supplies are likely to be limited for a couple more months. The rising price of gasoline to consumers is in effect the market's way of rationing that limited supply of oil.

Now suppose that we were to cut gasoline taxes. If the price of gas at the pump were to fall, motorists would buy more gas. But there isn't any more gas, so the price at the pump, inclusive of the lowered tax, would quickly be bid right back up to the pre-tax-cut level. And that means that any cut in taxes would show up not in a lower price at the pump, but in a higher price paid to distributors. In other words, the benefits of the tax cut would flow not to consumers but to other parties, mainly the domestic oil refining industry. (As the textbooks will tell you, reducing the tax rate on an inelastically supplied good benefits the sellers, not the buyers.)

A cynic might suggest that that is the point. But I'd rather think that Mr. Bush isn't deliberately trying to throw his friends in the oil industry a few extra billions; I prefer to believe that the candidate, or whichever adviser decided to make gasoline taxes an issue, was playing a political rather than a financial game.

There still remains the argument that the only good tax is a dead tax. This leads us into the whole question of whether those huge federal surplus projections are realistic (they aren't), whether the budget is loaded with fat (it isn't), and so on. But anyway, the gasoline tax is dedicated revenue, used for maintaining and improving the nation's highways. This is one case in which a tax cut would lead directly to cutbacks in a necessary and popular government service.

You could say that I am making too much of a mere political gambit. Gasoline prices have increased more than 50 cents per gallon over the past year; Mr. Bush only proposes rolling back 1993's 4.3-cent tax increase.

But the gas tax proposal is nonetheless revealing. Mr. Bush numbers some of the world's leading experts on tax incidence among his advisers. I cannot believe that they think cutting gasoline taxes is a good economic policy in the face of an OPEC power play. So this suggests a certain degree of cynical political opportunism. (I'm shocked, shocked!) And it also illustrates the candidate's attachment to a sort of knee-jerk conservatism, according to which tax cuts are the answer to every problem.

As a citizen, then, I deplore this proposal. As a college lecturer, however, I am delighted.

Wednesday, May 10, 2006

Biomass as an Energy Source

John Deutch, "director of energy research and undersecretary of Energy in the Carter administration, ... director of the CIA and deputy secretary of Defense in the first Clinton administration, [and] professor of chemistry at MIT" is enthusiastic about cellulosic biomass as an energy source:

Biomass Movement, by John Deutch, Commentary, NY Times: President Bush has made the welcome point that the U.S. needs "to move beyond a petroleum-based economy," and has lent his support to the need to develop energy from biomass... This is popular with the public and also enjoys significant support in Congress. Unfortunately, congressional subsidies for biomass are driven by farm-state politics rather than by a technology-development effort that might offer a practical liquid fuel alternative to oil. ...

Biomass can be divided into two classes: food-crop and cellulosic. Natural enzymes can easily break down food-crop biomass such as corn to simple sugars, and ferment these sugars to ethanol. Cellulosic biomass -- which includes agricultural residues from food crops, wood and crops such as switch grass -- cannot easily be "digested" by natural enzymes.

Today, we use corn to produce ethanol in an automobile fuel known as "gasohol" -- 10% ethanol and 90% gasoline. Generous federal and state subsidies, largely in the form of exemption from gasoline taxes for gasohol, explain the growth of its use... Politicians from corn-states and other proponents of renewable energy support this federal subsidy, but most energy experts believe using corn to make ethanol is not effective in the long run because the net amount of oil saved by gasohol use is minimal.

In the U.S., ... a significant amount of oil and natural gas is used in growing, fertilizing and harvesting [corn]. Moreover, there is a substantial energy requirement -- much of it supplied by diesel or natural gas -- for the fermentation and distillation process that converts corn to ethanol. ... While there is some quarreling among experts, it is clear that it takes two-thirds of a gallon of oil to make a gallon equivalent of ethanol from corn. Thus one gallon of ethanol used in gasohol displaces perhaps one-third of a gallon of oil or less. A federal tax credit of 10 cents per gallon on gasohol, therefore, costs the taxpayer a hefty $120 per barrel of oil displaced cost. Surely it is worthwhile to look for cheaper ways to eliminate oil.

The economics are not the same in other countries. Brazil is a well-known example, where sugarcane grows in the tropical climate and conventional fermentation and distillation readily yields ethanol. Ethanol is said to provide 40% of automobile fuel in Brazil and compete with gasoline without government subsidy. Depending on the future world price of sugar and the lessening of trade restrictions on both sugar and sugar-derived ethanol, Brazil could become a net exporter of this biofuel.

The situation in the U.S. is quite different for cellulosic biomass, because much less petroleum is used in its cultivation. There are two paths to convert this material to liquid fuel. In the chemical approach the cellulosic feedstock is gasified with oxygen to produce synthesis gas... This "syngas" can be converted by conventional chemical techniques into liquid fuel suitable for transportation use. The cost, although uncertain and dependent upon local production conditions, is in the range of $50 to $70 per barrel of oil, which explains why, until now, it has not attracted a great deal of attention.

The biotech approach, by contrast, seeks to produce new enzymes that will break down the difficult-to-digest cellulosic feedstock into simple sugars... This approach merits genuine enthusiasm... Realizing this exciting prospect will not be easy... Success will require a sustained research effort; it is too early to estimate the production costs of this method, because process conditions are unknown. However, the expected fossil energy inputs for cellulosic biomass will be much less than that of gasohol, because the energy cost for cultivation is less, and because the portion of the cellulosic material not converted to ethanol can be burned to provide process heat -- thus substantially lowering the implied cost of federal tax subsidies per barrel of oil displaced.

I will be astonished, but delighted, if the cost of ethanol or other biomass-derived chemicals proves to be less than $40 per barrel of its oil equivalent, and if large-scale production can be accomplished in six years.

Critics of biomass argue that the conversion of sunlight into plant material is "inefficient," and that impractically large amounts of land would be required to produce significant amounts of transportation fuel. Both arguments are overstated. We should be humble about calling natural photosynthesis "inefficient" -- especially since we clever chemists cannot accomplish any artificial photosynthesis in the lab. At present, artificial photosynthesis is not an option, but it is an important basic research goal.

As for the land required to support significant biofuel production from a dedicated energy crop, switch grass offers a basis for estimation. ... [T]he land ... needed to displace one million barrels of oil per day (about 10% of U.S. oil imports projected by 2025), is 25 million acres (or 39,000 square miles). This is roughly 3% of the crop, range and pasture land that the Department of Agriculture classifies as available in the U.S. I conclude that we can produce ethanol from cellulosic biomass sufficient to displace one to two million barrels of oil per day in the next couple of decades, but not much more. This is a significant contribution, but not a long-term solution to our oil problem. ...

Saturday, May 06, 2006

Daniel Gross: Why Gas Prices Don't Matter to Consumers

Daniel Gross argues that "rising gas prices may not be as economically damaging as has been assumed":

Why Prices at the Pump May Have Little Bite, by Daniel Gross, Economic View , NY Times: As the summer driving season approaches, gas prices have been soaring ... But the steep prices don't seem to be curbing the enthusiasm of American consumers. Same-store sales at Wal-Mart, those for stores open at least a year, rose a solid 6.8 percent in April. Last week, the Conference Board reported that the consumer confidence index for April hit its highest level since May 2002...

These data point to the enormous resilience of the consumer. But they also bring into focus a truism lost in the miasma of media coverage and political rhetoric...: while the price of gasoline may be highly visible and symbolic, filling up the tank simply doesn't eat up that much of most families' budgets.

How much will Americans spend this year to satisfy their gasoline habit? It's hard to know precisely. But there are clues in government data. In the Consumer Price Index, the inflation gauge, gasoline has a weighting of 4.15 percent... In other words, about four pennies of every American's consumer dollar wind up in the gas tank...

Based on data collected in the bureau's consumer expenditure surveys in 2004, consumer expenditures per household ... on gasoline and motor oil, with gasoline accounting for virtually the entire sum, were 3.7 percent... [of income on average].

Since then, this amount has certainly risen with the price of gasoline, but so has average income. John Felmy, chief economist at the American Petroleum Institute in Washington, estimates that in 2006 the average household will devote ... expenditures to gasoline  ...[of] 4.6 percent.

"This proportion is certainly up from recent years, but it is something that most households can cope with," said Carl Steidtmann, chief economist at Deloitte Research. The difference in spending on gasoline from 2004 to 2006, then, is an extra $10.62 a week...

Drill down a little further, and it becomes apparent why rising gas prices may not be as economically damaging as has been assumed. ... [C]onsumers with a greater ability to absorb the pain of higher gasoline prices buy a disproportionately large amount of the stuff. In 2004, ... the ... 41.4 percent of households that earned more than $50,000 accounted for 58.4 percent of total expenditures. Even at the higher prices, these comparatively better-off households — which account for 64 percent of overall consumer spending — are still devoting only a small fraction of their total spending to gas.

Maybe that is why prices near $3 a gallon haven't put a significant dent in Americans' overall gasoline use... Compared with switching from a car to a commute by bus or train, or undertaking the expense of buying a new, more fuel-efficient car, paying more for gas is a minor inconvenience for many consumers.

That doesn't mean Americans should be complacent. Expensive gas is a burden for those at the lower end of the income scale, whose wages have generally stagnated during this expansion. ... consumer confidence fell in April among households making less than $35,000.

Ken Goldstein, a Conference Board economist, says that people who worry about the impact of expensive oil shouldn't look just at the prices at the local Mobil station. When a spike in a crucial commodity evolves into a long-lasting plateau, the higher costs can spill over into a wide range of other products and services.

"We haven't seen the high price of oil show up in the prices of chemicals, plastics, paint and rubber yet," Mr. Goldstein said. "But when it happens, it is going to drive up the cost of a lot of goods."

I wonder what the percentage would be if the definition was widened, as suggested at the end, to include home heating costs, the feed through to other goods, and so on. It would also be interesting to know what percent the four cents or so spent on gas is of monthly discretionary spending rather than total spending. But inflation has been mild and there is something else that may make the effects more consequential.

Consumers may not be paying higher prices for the goods they purchase, but they may not have as much income available to purchase goods. Many argue that the reason oil price increases have not passed through to output prices is that oil price increases are being offset by holding down wage growth and letting productivity increases compensate for higher energy costs. If so, then these estimates won't capture the lower income share that consumers would have as a result.

Friday, May 05, 2006

The Elasticity of Oil Supply

An email says to take a look at this article from The Economist discussing how Exxon's investment plans have responded to recent developments in the oil industry:

Texan sangfroid, The Economist: ...Rex Tillerson, ... took over as the head of Exxon Mobil at the beginning of the year. Over the past five months, the price of oil has hit $75 a barrel, Exxon has announced the biggest profits in corporate history... Yet Mr Tillerson claims that none of this upheaval has much bearing on how Exxon is run. The firm will stick to the same strategy, he insists, making the same investment decisions based on the same assumptions about the future of the industry as it did last year. In fact, he goes even further: Exxon's strategy has not changed since 1998, when oil sold for as little as $10 a barrel.

That is quite an assertion at a time when many are arguing that the oil industry is on the verge of a cataclysm. ... But as far as Mr Tillerson is concerned, this is just the typical hyperbole that always accompanies upswings in oil's boom-and-bust cycle. As a lifelong oilman, Mr Tillerson should know. He grew up in a former oil boomtown, Wichita Falls, Texas (“the city that faith built”). ... During the course of his career, he has managed oilfields everywhere from Arkansas to Yemen.

What is more, Mr Tillerson is the chosen successor of Lee Raymond, Exxon's previous boss. Mr Raymond's 12-year tenure was a period of unparalleled success for the company. ... Ruthless financial discipline underpins that rise: last year, for example, Exxon earned 31 cents on every dollar it spent, half as much again as its nearest rival, BP. That helps to explain those record profits, of more than $36 billion last year.

Exxon pursues only projects that will turn a profit even in the leanest years, Mr Tillerson explains; so in the fattest ones, the returns are eye-catching. True to that policy, he will not be seduced into making expensive investments on the assumption that the oil price will remain high. ... Traders, he argues, are pushing the price up on speculation about possible future supply shocks, rather than any actual shortfall. Exxon, after all, refines even more oil than it pumps, yet has never had any trouble buying supplies to feed its refineries.

Anyway, oilfields take so long to develop, and are in production for such a long time, he says, that the oil price of the day, whether high or low, “is almost entirely irrelevant” to investment decisions. ... Mr Tillerson claims that the threshold at which Exxon considers a project commercially viable has not budged at all. The firm revisits a scheme that it has previously discarded only if improvements in technology change its economics—not simply because the oil price has spiked.

Despite this choosiness, however, Mr Tillerson maintains that Exxon is not short of opportunities. ... it is helping to tap the world's biggest gas field in Qatar, and has just signed a deal to develop an oilfield in the United Arab Emirates. Unlike most other Western firms, it recently sold its stake in a Venezuelan field rather than submit to higher taxes—suggesting that it is not desperate for oil to pump. Exxon estimates its total “resource base” of possible, probable and proven reserves at 73 billion barrels, which would last 49 years at the rate it is pumping.

There is a self-serving political element to this line, of course. If Exxon's record profits are the result of years of shrewd and disciplined investment, rather than an unexpected and undeserved windfall, it is harder to argue ... that they should be taxed away. It is also harder to complain about Messrs Raymond's and Tillerson's record pay. ...

Mr Tillerson is making a genuine—and risky—choice. Some rivals, such as BP, are piling into renewables such as solar power. Others, including Chevron, have bought rival oil firms despite the cost. Still others, such as Royal Dutch Shell, have rapidly increased their spending on exploration and development. But Mr Tillerson says that he plans to run the company without making any bets on the oil price. That, in itself, is a gamble: if it remains high, and he sticks to his guns, then Exxon will lose ground to its competitors.

A couple of thoughts from someone with no claim as "a lifelong oilman," and who grew up in a town built by economics rather than "faith."

I would have increased my assessment of future world economic growth, and hence oil demand, with the new information that has arrived since 1998. Revisiting plans "only if improvements in technology change its economics," a supply factor, ignores permanent changes in demand from higher world economic growth. These changes in demand differ from the transitory changes in demand over the boom-and-bust cycle highlighted in the discussion. Also, the requirement that an investment project return a profit in all possible states of the world in order for it to be viable seems overly conservative, but maybe I don't understand the principle of "choosiness."

Friday, April 28, 2006

Economic Freedom and Oil Prices

I'll be curious to hear what you think about this Economic Letter from the Dallas Fed, particularly this statement:

Oil prices are rising—not because the world is running out of oil but because the bulk of reserves are in countries where market incentives cannot work fully or in the hands of monopolists who may be exercising their power by restraining investment.

The claim is that a large factor in expaining high oil prices is lack of economic freedom which limits the ability of major oil producing countries to bring supplies to the marketplace. Here's the paper:

Running on Empty? How Economic Freedom Affects Oil Supplies, by Stephen P. A. Brown and Richard Alm Economic Letter, Federal Reserve Bank of Dallas, Vol. 1, No. 4, April 2006: Oil prices have marched upward in recent years, ending nearly two decades of relatively cheap energy. ... (Chart 1). In April 2006, oil reached an all-time high of more than $75 a barrel, measured in current dollars.[1]

In explaining today's high oil prices, many analysts point to surging demand from China, India and other rapidly industrializing countries and cyclical growth in U.S. consumption. When added to existing demand from Europe, Asia and elsewhere, these increases have outstripped any gains in global production and reduced excess capacity to near zero. The analysts expect economic development to continue apace in China and India, with their appetites for oil growing as fast as or faster than their economies.[2]

Are we running out of oil? The question always arises when oil prices spike. Some experts—including Matthew Simmons, author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy—argue that world oil production is at or near its peak and prices will just continue to rise, perhaps toward $200 a barrel or more...

Continue reading "Economic Freedom and Oil Prices" »

Wednesday, April 26, 2006

Clinton Did It!

Dean Baker evaluates Bush's inference that Clinton is responsible, in part, for higher oil prices:

Beat the Press: Arctic Oil Nonsense, by Dean Baker:  ... President Bush claimed today that the country would be producing another million barrels of oil a day, if President Clinton had allowed drilling in the refuge. ... implying President Clinton’s opposition to drilling in the refuge is a major factor behind today’s high oil prices.

A few simple facts indicate otherwise. First, there is a world market for oil. What matters in determining the price of oil is how much oil is supplied in the world, not how much is supplied in the United States. ... One million barrels is less than 1.2 percent of world oil supply. That is not trivial, but it will not hugely affect the world price of oil.

The second point follows directly from the first. Iraq’s average oil output is approximately 1 million barrels a day less than it was before the war. ... the same amount that drilling in the refuge might have increased it.

The third point is that the oil in the Refuge is a temporary fix. According to the Energy Information Agency, it would take approximately 10 years to reach the peak production of 1 million barrels a day. This peak production would continue for approximately 10 years, and then it would trail back down to zero over roughly 10 years. This means that if we had begun drilling in the Refuge the day Clinton took office in 1993, then we would have hit peak production just over three years ago, and we would begin to see a decline in output beginning in 2013. This is not exactly long-term energy security.

Of course, there is plenty that Clinton can be blamed for regarding energy policy. For example, if he had introduced mileage standards that increased average mileage by just 10 percent, this would save the country 1 million barrels a day of oil consumption ...

The NY Times also comments on the president's remarks:

How Not to Cure an Addiction, Editorial, NY Times: During his State of the Union speech last January, President Bush correctly diagnosed America's oil consumption as an addiction. Unfortunately, Mr. Bush is balking at taking the steps to cure the abuse.

Yesterday, the president told an audience ... that he would try to lower gasoline prices by increasing the supply of oil ... His plan is to refrain from topping off the nation's Strategic Petroleum Reserve, but it ... is nearly full already, so skipping a few deposits won't appreciably affect supply or prices. ...

Mr. Bush's other recommendations were similarly off point. For instance, he acknowledged that higher prices reflected global demand. But he offered no strategy to combat demand-driven price rises. The obvious solution, to increase fuel efficiency standards for ordinary cars, was not mentioned. ...

The president made no mention of the Iraq war, which pushes up prices by reinforcing the market's anxiety over political upheaval in oil-producing areas. But he did make another pitch for drilling in protected Alaskan wilderness.

The alternative energy technologies Mr. Bush emphasized — biofuels, hybrids, hydrogen power — are important and promising. What's missing is a plan to get us from here to there...

Finally, The Wall Street Journal adds:

Despite critics' dismissal of the White House moves, the actions -- particularly relaxing clean-fuel standards -- could affect prices, oil analysts said...

Update: Maybe Dean Baker had an impact:

TPM: TPM Reader: TPM Reader PON finds this exchange from White House National Economic Council Director Al Hubbard's briefing yesterday on the president's 'Four Point Energy Plan' ...

Q Just to follow up, though, on one element of that point. The President made the point that had ANWR been approved ten years ago, you'd get about a million barrels a day. Had the Iraq production resumed to the level that had been projected before the war, how much would that contribute today?
DIRECTOR HUBBARD: I actually don't know the precise answer to that. What's really most important, though, is that we've become less reliable on overseas sources of crude oil and other sources of energy, and more reliant on energy from within our 50 states [sic].

Q You have no estimate, though, about what Iraqi production could be?
DIRECTOR HUBBARD: I do not have it.
MR. HENNESSEY: We can get back to you. DIRECTOR HUBBARD: Yes, we can get back to you with that, or --

Q That would be useful. I mean, just -- obviously, since the President has chosen one interesting example in ANWR, the Iraq one would be an interesting one to compare it to, whether that would be more or less than a billion -- a million a day.
DIRECTOR HUBBARD: Yes, we will have to get back to you on that.

Can I get back to you on that? Can I leave now?

Monday, April 17, 2006

Paul Krugman: Enemy of the Planet

Paul Krugman tackles the trashing of science by oil companies, Exxon in particular, to cloud research pointing to global warming. He also notes how the press, in its quest to be balanced, aids and abets this effort:

Enemy of the Planet, by Paul Krugman, Commentary, NY Times: Lee Raymond, the former chief executive of Exxon Mobil, was paid $686 million over 13 years. But that's not a reason to single him out for special excoriation. Executive compensation is out of control in corporate America as a whole, and unlike other grossly overpaid business leaders, Mr. Raymond can at least claim to have made money for his stockholders.

There's a better reason to excoriate Mr. Raymond ... he turned Exxon Mobil into an enemy of the planet. To understand why Exxon Mobil is a worse environmental villain than other big oil companies, you need to know a bit about how the science and politics of climate change have shifted over the years.

Global warming emerged as a major public issue in the late 1980's. But at first there was considerable scientific uncertainty.

Over time, the accumulation of evidence removed much of that uncertainty. ... there's now an overwhelming scientific consensus that the world is getting warmer, and that human activity is the cause. ... To dismiss this consensus, you have to believe in a vast conspiracy to misinform the public that somehow embraces thousands of scientists around the world. That sort of thing is the stuff of bad novels. ...

So how have corporate interests responded? In the early years, ... many companies from the oil industry, the auto industry and other sectors were members of a group called the Global Climate Coalition, whose de facto purpose was to oppose curbs on greenhouse gases. But as the scientific evidence became clearer, many members — including oil companies like BP and Shell — left the organization and conceded the need to do something about global warming.

Exxon, headed by Mr. Raymond, chose a different course of action: it decided to fight the science.

A leaked memo from a 1998 meeting ... describes a strategy of providing "logistical and moral support" to climate change dissenters, "thereby raising questions about and undercutting the 'prevailing scientific wisdom.' " And that's just what Exxon Mobil has done: lavish grants have supported a sort of alternative intellectual universe of global warming skeptics.

The people and institutions Exxon Mobil supports aren't actually engaged in climate research. They're the real-world equivalents of the Academy of Tobacco Studies in the movie "Thank You for Smoking," whose purpose is to fail to find evidence of harmful effects.

But the fake research works for its sponsors, partly because it gets picked up by right-wing pundits, but mainly because it plays perfectly into the he-said-she-said conventions of "balanced" journalism. A 2003 study ... of reporting on global warming in major newspapers found that a majority of reports gave the skeptics — a few dozen people, many if not most receiving ... financial support from Exxon Mobil — roughly the same amount of attention as the scientific consensus, supported by thousands of independent researchers.

Has Exxon Mobil's war on climate science actually changed policy for the worse? Maybe not ... the Bush administration has done nothing, it's not clear that policies would have been any better even if Exxon Mobil had acted more responsibly.

But the fact is that whatever small chance there was of action to limit global warming became even smaller because Exxon Mobil chose to protect its profits by trashing good science. And that, not the paycheck, is the real scandal of Mr. Raymond's reign as Exxon Mobil's chief executive.

Previous (4/14) column: Paul Krugman: Weapons of Math Destruction
Next (4/21) column: Paul Krugman: The Great Revulsion

Sunday, April 16, 2006

Global Warming and Nuclear Power

Lots of research says that I will overestimate the risk of events such as a core meltdown in a nuclear power plant. And I'm sure I do. But knowing and allowing for that, or trying, I still can't find a way to endorse a strong movement toward nuclear power. My hesitation to support nuclear power is not very green according to many environmentalists. But are we positive we can't find any other solutions? Should simply resign ourselves to the nuclear power age?:

Going Nuclear A Green Makes the Case, by Patrick Moore, Commentary, Washington Post: In the early 1970s when I helped found Greenpeace, I believed that nuclear energy was synonymous with nuclear holocaust, as did most of my compatriots. ... Thirty years on, my views have changed, and the rest of the environmental movement needs to update its views, too, because nuclear energy may just be the energy source that can save our planet from ... catastrophic climate change.

Look at it this way: More than 600 coal-fired electric plants in the United States produce 36 percent of U.S. emissions -- or nearly 10 percent of global emissions -- of CO2, the primary greenhouse gas responsible for climate change. Nuclear energy is the only large-scale, cost-effective energy source that can reduce these emissions while continuing to satisfy a growing demand for power. And these days it can do so safely.

I say that guardedly, of course, just days after Iranian President Mahmoud Ahmadinejad announced that his country had enriched uranium. ... And although I don't want to underestimate the very real dangers of nuclear technology in the hands of rogue states, we cannot simply ban every technology that is dangerous. ... In 1979, Jane Fonda and Jack Lemmon produced a frisson of fear with their starring roles in "The China Syndrome," a fictional evocation of nuclear disaster in which a reactor meltdown threatens a city's survival. Less than two weeks after the blockbuster film opened, a reactor core meltdown at Pennsylvania's Three Mile Island nuclear power plant sent shivers of very real anguish throughout the country.

What nobody noticed at the time, though, was that Three Mile Island was in fact a success story: The concrete containment structure did just what it was designed to do -- prevent radiation from escaping ... And although the reactor itself was crippled, there was no injury or death... Three Mile Island was the only serious accident in the history of nuclear energy generation in the United States, but it was enough to scare us away from further developing the technology: There hasn't been a nuclear plant ordered up since then.

Today, there are 103 nuclear reactors quietly delivering just 20 percent of America's electricity. ... And I am not alone among seasoned environmental activists in changing my mind on this subject. British atmospheric scientist James Lovelock, father of the Gaia theory, believes that nuclear energy is the only way to avoid catastrophic climate change. Stewart Brand, founder of the "Whole Earth Catalog," says the environmental movement must embrace nuclear energy... On occasion, such opinions have been met with excommunication from the anti-nuclear priesthood...

There are signs of a new willingness to listen, though, even among the staunchest anti-nuclear campaigners. ... Here's why: Wind and solar power have their place, but because they are intermittent and unpredictable they simply can't replace big baseload plants such as coal, nuclear and hydroelectric. Natural gas, a fossil fuel, is too expensive already, and its price is too volatile to risk building big baseload plants. Given that hydroelectric resources are built pretty much to capacity, nuclear is, by elimination, the only viable substitute for coal. It's that simple.

That's not to say that there aren't real problems -- as well as various myths -- associated with nuclear energy. Each concern deserves careful consideration:

Continue reading "Global Warming and Nuclear Power" »

Friday, February 17, 2006

Tax Breaks for Oil Companies

The Chicago Sun Times is not happy about welfare payments to oil companies:

Now's a curious time to be dishing out oil welfare, Editorial, Chicago Sun Times: The U.S. government over the next five years will give a windfall of $7 billion to oil companies -- yes, the same oil companies that reported record profits last year. But wait, it gets worse: If one oil company that is suing the government succeeds, that windfall could hit nearly $35 billion. Oh, and one more thing: There appears to be little anyone can do about it. Think about that the next time you pay a small fortune to fill your tank.

There is nothing illegal about the program... In fact, some folks might argue its goals were laudable 10 years ago, when the federal government with bipartisan support tried to encourage oil companies to drill in the deep waters of the Gulf of Mexico by promising to forgo the normal 12 percent or 16 percent royalty payments on leases there. Oil and gas prices were relatively low at the time, and it was deemed too financially risky for oil companies to invest in deep water drilling without the incentive. But isn't taking risks in hopes of gaining future profits what the market is all about? This was a bad idea from the start. ...

Many companies stopped claiming relief when oil and gas prices rose above certain trigger points built into the leases -- about $35 per barrel for oil. But those price triggers were waived in leases signed in 1998 and 1999 because companies still weren't investing ... and those leases will account for most of the $7 billion windfall. And several companies are challenging whether the Interior Department had the authority to include those price triggers in the first place. ...

While some lawmakers said they will try to undo the terms of leases that are in some cases 10 years old, they will probably fail. ... While we don't favor a new tax on the oil companies' record profits, those firms aren't doing themselves any favors by refusing to pay royalties while they're rolling in the dough. They might find it hard to win incentives the next time their industry is in a slump. We can hope so. The oil industry can make plenty of money without the benefit of corporate welfare.

I don't know much about the challenges to the price triggers, but on the $7 billion I am not quite as shrill. This isn't what I think of as welfare, this was an attempt to use incentives to encourage more investment by oil companies. The debate on whether incentives should be offered in the first place aside, if profits are dangled in front of firms as an incentive to encourage investment or other behavior, then it undermines the policy the next time you try to use it if you take the profits away from the firms that act on the incentive because they are excessive by some definition. If excess profits are a worry, then write the policy to cap or limit profits up front (or in this case leave them in place) so that firms know the true reward for investment, don't take the profits away or use the profits as political weapons after the fact.

Thursday, February 16, 2006

A Gasoline Tax Proposal That Sounds Too Good to be True

Robert Frank explains the virtues of a gasoline tax offset by a reduction in payroll taxes:

A Way to Cut Fuel Consumption That Everyone Likes, Except the Politicians, by Robert H. Frank, Economics Scene, NY Times: Suppose a politician promised to reveal the details of a simple proposal that would ... produce hundreds of billions of dollars in savings for American consumers, significant reductions in traffic congestion, major improvements in urban air quality, large reductions in greenhouse gas emissions, and substantially reduced dependence on Middle East oil. The politician also promised that the plan would require no net cash outlays from American families...

[I]f something sounds too good to be true, it probably is. So this politician's announcement would almost surely be greeted skeptically. Yet a policy that would deliver precisely the outcomes described could be enacted by Congress tomorrow — namely, a $2-a-gallon tax on gasoline whose proceeds were refunded to American families in reduced payroll taxes. Proposals of this sort have been advanced frequently in recent years by both liberal and conservative economists. Invariably, however, pundits ... dismiss these proposals as "politically unthinkable."

But if higher gasoline taxes would make everyone better off, why are they unthinkable? Part of the answer is suggested by the fate of the first serious proposal to employ gasoline taxes to reduce America's dependence on Middle East oil. The year was 1979 ... To encourage conservation, President Jimmy Carter proposed a steep tax on gasoline, with the proceeds to be refunded in the form of lower payroll taxes.

Mr. Carter's opponents mounted a rhetorically brilliant attack..., arguing that because consumers would get back every cent they paid in gasoline taxes, they could, and would, buy just as much gasoline as before. Many found this argument compelling, and in the end, President Carter's proposal won just 35 votes in the House of Representatives.

The experience appears to have left an indelible imprint on political decision makers. To this day, many seem persuaded that tax-cum-rebate proposals do not make economic sense. But it is the argument advanced by Mr. Carter's critics that makes no sense. It betrays a fundamental misunderstanding of how such a program would alter people's opportunities and incentives. ...

A second barrier to the adoption of higher gasoline taxes has been the endless insistence by proponents of smaller government that all taxes are bad. ... But as even the most enthusiastic free-market economists concede, current gasoline prices are far too low, because they fail to reflect the environmental and foreign policy costs associated with gasoline consumption. ...

At today's price of about $2.50 a gallon, a $2-a-gallon tax would raise prices by about 80 percent ... Evidence suggests that an increase of that magnitude would reduce consumption by more than 15 percent in the short run and almost 60 percent in the long run. These savings would be just the beginning, because higher prices would also intensify the race to bring new fuel-efficient technologies to market.

The gasoline tax-cum-rebate proposal enjoys extremely broad support. Liberals favor it. Environmentalists favor it. The conservative Nobel laureate Gary S. Becker has endorsed it, as has the antitax crusader Grover Norquist. President Bush's former chief economist, N. Gregory Mankiw, has advanced it repeatedly. In the warmer weather they will have inherited from us a century from now, perspiring historians will struggle to explain why this proposal was once considered politically unthinkable.

Monday, February 06, 2006

Variable Pricing of Electricity

The ability to use peak load pricing to regulate electricity usage is coming to California. That's good, except for the large number of meter readers that will lose their jobs:

New Power Meters Show Users the Money, by Marc Lifsher , LA Times: ...California regulators and two of the state's biggest utilities. Pacific Gas & Electric Co. and San Diego Gas & Electric Co. plan to spend $2 billion over the next several years installing millions of the advanced meters in homes across the Golden State. ... The meters are actually mini-computers that communicate with a utility's central data center, providing real-time information on how much electricity a customer is using and when it's being used. Data provided by the meters enable utilities to offer voluntary "variable pricing" plans. Under the plans, customers are charged more for power used during peak periods ... and less ... when demand and prices are lower.

The goal is to alleviate the state's power crunch by giving customers a financial reward for running their dishwashers at night — or dinging them for jacking up the air conditioning on hot afternoons. There's a bonus for utilities: They currently employ thousands of meter readers who periodically slip into backyards to manually record customers' electricity use — jobs that would go the way of the milkman if advanced metering became universal. "I always knew this was coming. Technology has pretty much taken over," said Mike Boyle, a PG&E worker who says he reads as many as 1,300 meters a day in Vacaville, northeast of San Francisco. ...

In the state-sponsored pilot project, high-tech meters were installed in 2,500 homes and the customers were billed under a variety of variable-pricing plans. Electricity use fell by an average of 13%. "The old straw that electricity demand [isn't affected by price] is not true at all," said Roger Levy, a consultant with the energy commission. ... The utility expects to recover most of the $1.6-billion cost of the program by eliminating its 900 meter readers and by shrinking other operational costs. ...

Friday, February 03, 2006

The Bigger the Oil Price Shock, the Harder We'll Fall

Martin Feldstein is worried that if oil prices go up again and depress economic activity, a falling saving rate won't to bail us out this time:

America will fall harder if oil prices rise, by Martin Feldstein, Commentary, Financial Times: The price of imported oil in the US doubled between summer 2003 and summer 2005, reducing consumers’ purchasing power by more than 1 per cent of gross domestic product. Nevertheless, the economic slowdown that was widely expected never occurred. Consumers kept spending and businesses kept investing. ... The continued strong growth contrasts sharply with the economic weakness that occurred after almost every previous significant rise in the oil price. How do we explain this remarkable difference? And what are the implications for the likely response to a future rise in oil prices?

The key to the economy’s strength in 2004 and 2005 was that household saving declined dramatically while the price of oil rose. ... This shift the annual rate of saving far outstripped the fall in income caused by the higher cost of oil. This fall in saving allowed households to raise consumption spending on non-oil goods and services while paying for the higher cost of imported oil. The primary cause of this dramatic shift was the fall in interest rates and the resulting rise in mortgage refinancing. Homeowners who refinanced their mortgages took out cash and reduced their monthly payments at the same time. Much of the cash obtained by refinancing was spent on consumer durables, home improvements and the like. The lower monthly payments permitted a higher level of sustained spending on all non-durable categories. ...

The faster increase in consumer spending caused businesses to invest more and raised the rate of growth of GDP. Faster GDP growth caused an accelerated rise in employment and a fall in the rate of unemployment. Mortgage interest rates were falling because the Federal Reserve’s fear of deflation had caused it to lower the short-term federal funds rate ... to the extremely low level of 1.0 per cent in 2003 and to leave it there in the first half of 2004 before beginning a very gradual process of rate increases. ... The lower mortgage rates induced refinancing and the subsequent gradual rise in rates induced additional refinancing by homeowners who wanted to borrow before rates rose further.

The powerful effect of mortgage refinancing on consumer spending was a very happy coincidence for the American economy at a time when oil prices were depressing consumers’ real incomes. If oil prices were to rise again in 2006 or 2007, the adverse effect on consumers’ real incomes would not be offset by increased mortgage refinancing. Mortgage refinancing has now peaked and is declining. The Federal Reserve is raising interest rates again to counter the inflationary pressures that remain from the rise in energy costs. And individuals no longer have the large amounts of household equity against which to borrow.

A rise in the oil price could happen again at any time. There is little spare capacity in global oil production and oil demand is rising rapidly in China and other Asian countries. A shock that reduced the production or shipping of oil could drive its price sharply higher. Speculative forces could compound this problem. The US was lucky after 2003 to escape the contractionary effect of an oil price rise even without an explicit change in monetary or fiscal policy. It would not be so lucky if a big oil price increase happened again now.

I don't always agree with Feldstein, but I do here.

Wednesday, February 01, 2006

Markets Can Fail? Really?

Senators are discovering that free markets are not necessarily competitive markets and talk of anti-trust legislation is being heard from both sides of the aisle:

US Senators in attack on oil industry mergers, by Stephanie Kirchgaessner, Financial Times: Washington lawmakers’ growing ire with the high price consumers are paying to heat their homes and fill their cars prompted new questions ... about the effects of consolidation in the oil industry, and whether it was time to re-think the nation’s anti-trust rules. Arlen Specter, the Republican chairman of the Senate judiciary committee, said the number of mergers in the oil industry had been “excessive”, and that record profits at giants like Exxon Mobil meant “it just may be time to legislate in this field”.

Senator Herb Kohl, a Democrat from Wisconsin, went further by calling for a break-up of the world’s largest oil companies, citing an independent congressional report that found that the more than 2,600 mergers and acquisitions in the industry since the 1990s had contributed to higher oil and gas prices. “We need to ask the serious question as to whether our anti-trust laws are sufficient,” he said. Chuck Schumer, the New York Democrat, agreed ...

The senators are worried about excessive profits, and they should be if they arise from market power. But in general high profits are not necessarily a bad thing. In a competitive market with free entry and exit, high profits are not a worry - high profits are the signal for more resources to flow into the industry. That's how the invisible hand works, but it's essential that the assumptions behind competitive markets are approximately satisfied for this mechanism to work properly.

In any case, I can't see much anti-trust action happening under this administration's watch.

What to Do with All Those Petrodollars?

Oil producing nations are looking for ways to diversify their economies to insulate against the inevitable swings in oil prices and the troublesome changes in government revenues that price swings bring about. They are also learning to manage the revenue cycles and, instead of spending lavishly when revenues exceed trend, the money is finding its way into T-bills, equity markets, and other financial instruments to await less prosperous times in the future. If these nations decide the higher oil prices are permanent rather than temporary, and that seems possible, they may be willing to invest more of the money domestically rather than saving for future rainy days. If so, then some of the funds flowing into financial markets will dry up:

New Money, New Ideas, by Jad Mouawad and Eduardo Porter, NY Times: ...Once again, oil producers ... are experiencing a boom. And just as they did in the 1970's and early 1980's, their coffers are spilling over with cash. Last time around, there was an abundance of outrageous projects, and judging from the extravagance on display in Dubai, lavish projects are finding financing once again. But this time around, the region's main oil producers, like Saudi Arabia, Kuwait, Qatar and the United Arab Emirates, have gotten wiser. Since the boom started three years ago, they have paid down their debt, saved more money than ever before and created more jobs in the private sector. And they are trying to diversify their economies away from oil and its increasingly volatile cycles.

"People are asking where are all the petrodollars and why we have not seen anything like the spending of the 70's and 80's," said Bader al-Saad, who runs the Kuwait Investment Authority. "What has changed is the economic and political reforms in the region..." he said. "If we hadn't learned from our previous mistake, this would have been a big stupidity." After the 1973 oil shock, governments in the Middle East spent 80 percent of their increase in revenue. Between 2003 and 2005, by contrast, they spent less than 40 percent of their new revenue... Governments have also whittled down their debt to an average 20 percent of gross domestic product last year, from about 40 percent in 2004.

Mohsin S. Khan, the director for the Middle East and Central Asia at the International Monetary Fund, said governments were still drawing up their budgets based on oil at $30 a barrel. ... Rachel Bronson, a specialist on Saudi Arabia at the Council on Foreign Relations... [says] "Unlike in the United States, where it feels like high prices are going to last forever, in the Middle East, the feeling is that it will not last..." Saudi Arabia, for example, tried to use its oil windfall of the 1970's and early 1980's to become an agricultural powerhouse. ... But then oil prices collapsed, and the Saudi government ran out of money. The costly effort to make the desert bloom then joined a list of financial follies...

So it is not surprising that the region's finance ministries are still not convinced that oil prices will remain high for very long, even as they shape their oil policies to keep prices from falling. ... Much of the Arab world's new wealth that is invested abroad ... ends up in the United States, in Treasury bonds as well as corporate and other government debt instruments. Thus, the Arab world is helping to finance America's enormous trade deficit. ...

Monday, January 09, 2006

Going Nuclear

Europe, like the U.S., is attempting to secure stable and environmentally sustainable energy sources for the future. To accomplish this goal, Wolfgang Munchau of the Financial Times says that Europe needs to consider nuclear energy as part of the answer. But the politics won't be easy:

EU must grasp the nuclear nettle, by Wolfgang Munchau, FT: The two overriding objectives of the European Union’s future energy policy should be to secure supplies and ensure environmental sustainability. It is currently in danger of failing in both. ... If Europe is serious about meeting both goals, it will need a new energy mix – one that would include both nuclear and alternative energy sources, combined with policies to encourage energy efficiency. While nuclear energy is not the answer to all our energy problems, it has to be part of any answer. The scientific and strategic case for a return to nuclear energy in the EU is overwhelming. ...

Nuclear energy is not risk-free. In the 1970s and 1980s, the debate was about whether we would be prepared to accept this new technology at the expense of what we were told would be a small accident risk. Today’s debate is different. For one, the accident risk is considerably smaller. But there are also equally grave risks attached to going non-nuclear, the biggest of which is an increase in greenhouse gas emissions. Scientists have been warning about the effects of phasing out nuclear energy on future greenhouse emissions. ...[If the energy] gap were filled by traditional power stations, the UK would almost certainly miss its greenhouse gas targets. ...

But it is far from clear whether the EU’s political classes are ready for a change in nuclear policy. ... For the present political generation, the anti-nuclear movement was one of the defining moments in their early political careers. It not only gave rise to green parties all over Europe but heavily influenced the political left – though, interestingly, this was never true of France ... Elsewhere in continental Europe, opposition to nuclear energy is so deep-rooted that even a dangerous rise in greenhouse gas emissions cannot change the views of a seasoned anti-nuclear campaigner. ... There are big differences among EU countries. Finland, for example, has been alone in commissioning a new power station at a time when others are decommissioning. ... Europe needs a common energy policy and it also needs a rethink on nuclear power. I am not holding my breath: there is too much political resistance. But let the debate commence.

Is it time for the U.S. to rethink its position too? I would listen to the arguments, but I'm not sold on nuclear. Here's a related story that points to reasons to reconsider:

Shell’s Sakhalin shows an industry its daunting future, by Thomas Catan, FT:  On a remote island off the eastern coast of Russia, encased in ice for nearly half the year, the future of the world oil and gas industry is beginning to take shape. And judging by the scale of the project ... around the bleak shores of Sakhalin, that future will be expensive, complex and, above all, big. Off Sakhalin’s north coast, two of the largest concrete structures ever built in Russia have been installed in the sea. As large as football fields and as tall as 15-storey buildings, the offshore platform bases have been towed in from 1,000 nautical miles away. Some 6,000 construction workers labour in temperatures that can reach minus 40 degrees laying 800km pipelines down the length of the island.

On the south side, Russia’s first liquefied natural gas plant is being built in Aniva Bay. There the natural gas will be super-cooled into liquid form and shipped to Japan, South Korea and the US – markets that have never before had access to Russia’s massive gas reserves. Europe came to realise just how dependent it had become on Russia for energy after a new year spat between the Kremlin and Ukraine briefly threatened its gas supply. Now Asia and the US are about to join the club. After decades of false starts, the big push is under way to transform Sakhalin into the world’s latest oil and gas province. ... “This is the biggest single project certainly that Shell has and, by most measures, that anybody has,” says Chris Finlayson, Shell’s Russia country manager. ... The project is burning through $100 a second and occupying 60m person-hours a year. ... the scale of the technical task that has led Shell managers to call it “the Mother of all Projects”. ... The list of obstacles faced by Shell and its partners is daunting. ...

Sakhalin’s pristine environment has ... made Shell the target of campaigners around the world. An endangered population of only 100 western gray whales feed on Sakhalin’s north-eastern shore during the summer months. ... Environmental groups also fear that the construction of the twin pipelines, which cross 1,000 rivers and streams, will interfere with salmon spawning and harm the island’s fishing industry. ... The company is drilling under rivers that are held to be particularly sensitive and has sought to allay fears about its impact on the island’s fishing industry. ... A bigger concern is that the company does not have a plan for what to do in the event of an oil spill under ice. It says it is working hard to come up with one. ...

Friday, January 06, 2006

Thomas Friedman: Living Green

Thomas Friedman continues to push for increased energy efficiency and independence:

The New Red, White and Blue, by Thomas L. Friedman, Commentary, NY Times: ...What's so disturbing about President Bush and Dick Cheney is that they talk tough about the necessity of invading Iraq, torturing terror suspects and engaging in domestic spying - all to defend our way of life and promote democracy ... But when it comes to what is actually the most important issue in U.S. ... policy today - making ourselves energy efficient and independent ... - they ridicule it as something only liberals, tree-huggers and sissies believe is possible or necessary.

Sorry, but being green, focusing the nation on greater energy efficiency and conservation, is not some girlie-man issue. It is actually the most tough-minded, geostrategic, pro-growth and patriotic thing we can do. Living green is not for sissies. Sticking with oil, ... saying that a country that can double the speed of microchips every 18 months is ... incapable of innovating its way to energy independence - that is for sissies, defeatists and people who are ready to see American values eroded at home and abroad. ...

The biggest threat to America and its values today is not communism, authoritarianism or Islamism. It's petrolism. Petrolism is my term for the corrupting, antidemocratic governing practices - in oil states from Russia to Nigeria and Iran - that result from a long run of $60-a-barrel oil. Petrolism is the politics of using oil income to buy off one's citizens with subsidies and government jobs, using oil and gas exports to intimidate or buy off one's enemies, and using oil profits to build up one's internal security forces and army to keep oneself ensconced in power - without any transparency or checks and balances. ...

Our energy gluttony fosters and strengthens various kinds of petrolist regimes. .... Most of these petrolist regimes would have collapsed long ago, ... but they were saved by our energy excesses. No matter what happens in Iraq, we cannot dry up the swamps of authoritarianism and violent Islamism ... without also ... bringing down the price of crude. A democratization policy in the Middle East without a different energy policy at home is a waste of time, money and, most important, the lives of our young people. That's because there is a huge difference in what these bad regimes can do with $20-a-barrel oil compared with the current $60-a-barrel oil. ...

We need a president and a Congress with the guts not just to invade Iraq, but to impose a gasoline tax and inspire conservation at home. That takes a real energy policy with long-term incentives ... - rather than the welfare-for-oil-companies-and-special-interests that masqueraded last year as an energy bill. Enough of this Bush-Cheney nonsense that conservation, energy efficiency and environmentalism are some hobby we can't afford. I can't think of anything more cowardly or un-American. Real patriots, real advocates of spreading democracy around the world, live green.

Green is the new red, white and blue.

Tuesday, January 03, 2006

Cato: Drain the Strategic Petroleum Reserve

Cato, in a big surprise for the new year, comes out against government intervention in markets:

Running on Empty, by Jerry Taylor and Peter Van Doren, Commentary, NY Times: The rise in fuel prices that followed Hurricanes Katrina and Rita has prompted many members of Congress to call for ... expanded federal reserves of crude oil, diesel fuel, home heating oil, jet fuel and propane. Proponents of stockpiling claim that if the government were to hoard those commodities when prices were low, it could unleash them on the market when supplies are tight, thus dampening price increases and stabilizing the market. But the experience in this country with the strategic petroleum reserve strongly suggests that such government-managed stockpiles are a waste of taxpayers' money. ... the reserve should be emptied and closed. ...

[A]fter adjusting for inflation, the petroleum reserve has cost federal taxpayers as much as $51 billion since it was created in 1975. ... Of course, even at that price, some would argue that the reserve is still worthwhile under certain circumstances. ... If large volumes of federal oil were released at the early stage of a supply shock, it could temper th[e] effects. But the government has never employed the reserve in this manner and probably never will. ... Another reason for the reluctance to tap the reserve is the widespread belief that it should be maintained as a hedge against an embargo like the one America experienced in 1973. But embargoes are not the powerful "oil weapon" that people think they are. Once a producer sells its oil on the world market, that oil can be bought, sold and rerouted repeatedly. ... The globalization of oil markets ensures that the United States will always have access to Persian Gulf oil whether OPEC members like it or not.

But what if, instead of an embargo, there was a catastrophic disruption in supply, say ... in Saudi Arabia? That scenario is worrisome, but the reserve would not be able to do much. No public stockpile would ever be large enough to deal with such a huge disruption. ... Regardless, getting rid of the public petroleum reserve would not mean destroying all oil reserves. Private oil inventories are three times larger than public inventories and would be even larger if investors didn't have to worry about the government flooding the market with public oil during a price spike. ... If the reserve is thought of as an insurance policy against high prices, the cost of the policy has been more expensive than the dangers the stockpile is meant to prevent. ...[W]e should sell while the selling is good.

Friday, December 30, 2005

Mammas Should Let Their Babies Grow Up To Use BioWillie?

Willie Nelson is pushing biodiesel as an alternative fuel, but many environmentalists are skeptical about biodiesel's net energy benefits and its ability to replace a substantial fraction of traditional oil-based fuel:

His Car Smelling Like French Fries, Willie Nelson Sells Biodiesel, by Danny Hakim, NY Times: Willie Nelson drives a Mercedes. But do not lose faith, true believers. The exhaust from Mr. Nelson's diesel-powered Mercedes smells like peanuts, or French fries, or whatever alternative fuel happens to be in his tank. ... Willie Nelson has birthed his own brand of alternative fuel. It is called, fittingly enough, BioWillie. And in BioWillie, Mr. Nelson, 72, has blended two of his biggest concerns: his love of family farmers and disdain for the Iraq war. BioWillie is a type of biodiesel, a fuel that can be made from any number of crops and run in a normal diesel engine. ... The rationale is that it is a domestic fuel that can provide profit to farmers and that it will help the environment, though environmentalists are not universally enthusiastic about it...

Every alternative to oil ... has its drawbacks. Biodiesel would reduce most emissions of smog-forming pollutants and global warming gases, and it could be used instead of foreign oil. But some studies show that it increases emissions of one harmful pollutant, nitrogen oxide, and it could not be produced in vast enough quantities to supplant oil-based fuel, or come close to it, unless the nation starts turning the suburbs over to farmland. And as with ethanol, producing great quantities of biodiesel from corn or soybeans could drive up food prices.

Bill Reinert, Toyota's national manager for advanced technologies, said ... "I frankly don't see biodiesel being an early alt-fuel player across a wide swath of geography. It's a boutique fuel. There's not enough payoff and not enough people into it." Peter J. Bell, the chief executive of ... a distributor of biodiesel that is working with Mr. Nelson, said of the nation's nearly 200,000 gas stations, "650 carry biodiesel, so we have a job in front of us."...

Daniel Becker, the Sierra Club's top global warming expert, said ... "In order to grow soybeans, you need multiple passes over the field with diesel tractors, you need a lot of fertilizer that's energy intensive to produce and, at the end of the day, you have a product that is no boon for the environment." He went on: "If you're going to go to the trouble of using an alternative fuel, use a good alternative fuel. If you really want to listen to Willie Nelson, go buy one of his records and play it in a hybrid."...

Tuesday, December 13, 2005

It's the Price of Gas, Stupid!

Paul Krugman is asked how Bush's poll numbers for his handling of the economy can be rising if people are dissatisfied with the economy's performance:

How's Bush Doing? Just Check the Price of Gas, Paul Krugman, Money Talks: Ronald Hernandez, Saint Amant, La.: ... if the economy is doing so poorly for the average Mary or Joe, then why are the latest polls consistently showing that more and more people are feeling better about it? ... And, oh yes, I am from the Katrina area and am well aware of how the Bush machine is working on its latest portrait. They are in the process of painting a picture of unpreparedness and incompetence within Louisiana's state and local governments in reaction to the worst natural disaster ever in the United States.

Paul Krugman: The latest polls do show some improvement in peoples' perception of the economy, although it's still strongly negative. But there's no mystery there: it's all about gasoline prices. It turns out that there's a stunningly close relationship between short-term movements in Bush's approval rating and changes in the price of gasoline. You can see it for yourself at an interesting web site, Professor Pollkatz's Pool of Polls. (The site is very anti-Bush but provides interesting data analysis whatever your politics.) In fact, given the fall in gas prices back to pre-Katrina levels, the surprising thing is how little of a boost Bush and his economic performance ratings have received.

Tuesday, November 22, 2005

Help for the Poor from Venezuela

The Bush administration motivates our neighbors to the south to help low-income U.S. residents pay for heating:

Chavez Pushes Petro-Diplomacy High Oil Profit Leads to Venezuela's Plan to Subsidize Heating in United States, by Justin Blum, Washington Post:  ...Citgo Petroleum Corp., a company controlled by the Venezuelan government of President Hugo Chavez, a nettlesome adversary of the United States who has accused the Bush administration of plotting to assassinate him and invade his oil-rich country... is planning to announce today that it will provide discounted heating oil this winter to many low-income residents of Massachusetts... The company also plans to offer similar aid in New York. ... The populist South American president would relish being able to show that Venezuela, far less wealthy than the United States, had come to the rescue of low-income people here. ... This is the second time in recent months that Chavez has used oil to tweak the United States... In September, Venezuela made a very public announcement about diverting shipments of gasoline to the United States to help prevent shortages after hurricanes Katrina and Rita...  The assistance might be viewed as altruistic by the United States, if not for the history of tension between the Bush administration and Chavez. In a September appearance at the United Nations, Chavez attacked the Bush administration for not doing more for the poor residents of New Orleans... He also said the United States was abetting "international terrorism" because it failed to arrest the Rev. Pat Robertson for saying that the United States should consider assassinating Chavez. ... Chavez ... concerns U.S. officials because he has repeatedly threatened to cut off oil shipments. Venezuela is one of the largest suppliers to the United States, providing about 1.5 million barrels a day of oil and oil products. Chavez has been seeking new markets for his oil, including energy-hungry China. ... The Venezuelan government said the oil-related initiatives ... are for humanitarian purposes and regional unity. ... Fadi Kabboul, minister-counselor for petroleum affairs ... [said] "Venezuela never used oil as a political weapon. Venezuela is not going to use oil against the U.S. as a political weapon for anything."

Monday, November 21, 2005

Facts About Gasoline

Here's a link to a report on the determination of gasoline prices. These graphs are from the GAO report "Understanding the Factors that Influence the Retail Price of Gasoline":


There is quite a bit more in the report.

Friday, November 18, 2005

Why Hasn't the Jump in Oil Prices Led to a Recession?

Via the San Francisco Fed:

FRBSF Economic Letter, Why Hasn't the Jump in Oil Prices Led to a Recession?, by John Fernald and Bharat Trehan: Oil prices have increased substantially over the last several years. When oil price increases of this magnitude occurred during the 1970s, they were associated with severe recessions. Why hasn't that happened this time around? This Letter explores some answers to that question.

Why should oil affect the economy?

When the price of oil rises, U.S. households and businesses who purchase fuel oil, gasoline, and other petroleum-based products have less disposable income to spend on other goods and services. However, for domestically produced oil, oil producers receive the extra income from the products they sell, so total U.S. income is not directly affected. Therefore, for domestic oil, a price increase represents a transfer from one group of U.S. residents (oil users) to another group of U.S. residents (oil producers).

The story is different for imported oil. An intuitive way to think about the initial effects of an increase in the price of imported oil on the economy is to consider it as a tax on domestic users. In 2004, the U.S. imported almost 5 billion barrels of energy-related petroleum products, amounting to about two-thirds of domestic petroleum use. Of these imports, 3.8 billion barrels were crude petroleum, or an average of 10.4 million barrels per day. For each $10/barrel increase in oil prices, the United States pays an effective "tax" of about $50 billion (5 billion barrels times $10), or 0.4% of GDP.

This is not the same thing as saying that GDP will fall by 0.4%. For instance, this estimate does not take into account what the foreign oil producers do with the additional income. It is likely that they would use at least part of this income to purchase goods from other countries. To the extent that these purchases consist of goods made in the U.S., they will help support U.S. GDP. Indeed, it is possible—in theory—to conceive of a situation where foreign oil producers purchase enough from the U.S. that U.S. GDP does not decline much, even though consumers are paying a higher price for oil and therefore can afford fewer goods and services themselves.

How big is the effect in practice?

As mentioned earlier, the experience of the 1970s suggests that oil shocks have a substantial effect on output. Indeed, Figure 1, which plots the real, inflation-adjusted price of imported petroleum, shows that high oil prices have frequently coincided with recessions. In a series of papers, Hamilton (1983, 1996, 2003) has argued forcefully that the oil shocks were responsible for these recessions. However, he argues that not all changes in the price of oil have the same effect on the economy. For instance, a fall in oil prices is unlikely to boost the economy in the same way that an increase can drag it down. In addition, he argues that oil price increases that simply reverse previous price decreases are unlikely to have a significant effect. One approach he recommends to isolate the kinds of price changes that can affect the economy is to record an oil shock only if the prevailing price of oil is higher than it has been over the past three years.

Figure 2 plots oil price shocks according to this recommendation. The spikes line up closely with recessions. From the figure, it is easy to find a clear statistical relationship between this oil-shock variable and output. Indeed, the magnitude of the predicted effect is much larger than the simple tax analogy suggests. This could reflect some sort of multiplier, as the loss in income in the first round would lead to a reduction in spending, which would imply a further loss in income, and so on. However, a simple statistical analysis does not provide insight into why the magnitude is so much larger than the direct income loss.

Moreover, the statistical evidence is not necessarily as strong as Figure 2 might suggest. Because an oil price shock is recorded if and only if oil reaches a three-year high, a temporary increase in the price of oil is treated as having the same impact as a permanent increase. But if the spike is temporary, then the effects on income are fleeting, and one would expect that many consumers will reduce their saving in order to avoid a big hit to consumption.

To see the point, compare the 1990 experience in Figures 1 and 2. Figure 1 shows that the price of oil spiked only briefly. But in Figure 2, which uses the Hamilton price-increase transformation, the 1990 spike was one of the largest. In Figure 2, this spike is followed by a long series of zeros. In Figure 1, however, more than 95% of the oil price increase is reversed next quarter and oil prices over the next year or two appear no different from the period preceding the spike. Indeed, more formal statistical analysis shows that over the post-1982 period the Hamilton oil shock variable has a significant negative impact on output only because of the spike in 1990. If the 1990 spike is set to zero, there is no evidence of a statistically important relationship.

Note also that the timing is suspect in several cases. The 1973-1975 recession began in November 1973; but oil prices surged in January 1974. The 1990-1991 recession began in July 1990; but oil prices surged in August.

Another way to get a sense of how large the effect of oil shocks may be is to consider the implications of more fully specified models, which incorporate the direct expenditure effects but then allow for additional, second round effects. These tend to suggest that the ultimate effects are roughly in line with the direct expenditure shares. In a recent paper, Guerrieri (2005) finds that a 50% increase in the price of oil starting in the first quarter of 2004 causes output to fall about 0.4% below what it would otherwise be in the long run (assuming that the Fed conducts policy using the well-known Taylor rule). The effects are likely to have been larger in the 1970s, when the economy was more energy-intensive; however, even if we assume that the economy's energy-intensity is unchanged since the 1970s, the effect is not likely to be huge.

Other explanations for the 1970s

Considerations like these have led a number of economists to suggest that the recessions of the 1970s reflected other kinds of shocks. For instance, Barsky and Killian (2001) argue that the great stagflation of the 1970s was the result of monetary policy alternating between periods of stimulation and restraint and not oil price shocks. Similarly, Burbidge and Harrison (1984) examine developments in five major industrial economies including the U.S. and conclude that even though the oil shocks in the early 1970s did have a significant effect, recessions were already on the way even before the jump in oil prices. They also find that the 1979-1980 oil shocks had a minimal effect on all these countries except Japan.

Others have argued that the recessions may have been caused by the Fed's reaction to the oil shocks. Bernanke, Gertler, and Watson (1997) show that postwar recessions have been preceded not only by rising oil prices but also by a tightening of monetary policy, which makes it difficult to distinguish between the effects of the two. According to them, the confusion between oil shocks and the response of monetary policy explains why oil shocks appear to have an effect that far exceeds what is expected based on a comparison of energy costs to total production costs. Their own analysis leads them to conclude that oil shocks have not played a major role in recessions and that endogenous monetary policy can account for a major portion (and sometimes all) of the effects attributed to oil shocks.

Is the current episode different?

It has also been suggested that the latest jump in oil prices has not had the usual effect on the economy because the price of oil has jumped for different reasons. For example, in the 1970s, the OPEC oil embargo and the fall of the Shah of Iran led to substantial reductions in the world supply of oil; similarly, the world supply fell in 1990 after Iraq's invasion of Kuwait. These seem like exogenous shocks to the world supply.

But much of the run-up in oil prices in the past few years seems to reflect the endogenous response of prices to the strength of global demand. The source of this higher demand turns out to be important. If the higher prices were the result of higher U.S. demand, then there would be little reason to fear a recession. It is hard to believe that the "tax" imposed by the oil price increase would exceed the increase in income that was the cause of the higher oil demand. But if the increase in demand originates abroad, things get more complicated. For instance, high oil prices which reflected rapid growth in China would have the same direct impact on the U.S. as a price increase engineered by OPEC, basically because higher oil consumption in China coupled with a relatively inelastic supply means that less oil is available to the U.S. There is a potential offset to this effect, as more rapid growth in China is likely to be accompanied by higher imports. Thus, countries that export significant amounts to China relative to their size will benefit from the rapid Chinese growth. The U.S. is not one of these countries, however, so that for the U.S. an increase in the price of oil due to higher demand from China is probably similar to an increase due to a reduction in supply.


Our discussion suggests that the answer to the question posed in the title has two parts. First, looking only at the correlation between some measure of the price of oil and output tends to exaggerate the role that oil price shocks played in the recessions of the 1970s, at least partly because one ends up ignoring the other things that were going on at that time. Second, an increase in the price of oil that reflects higher demand will not have the same effect as a decrease in supply. Here, though, it is useful to keep in mind that price increases that reflect higher growth in other countries will have the same effect on the U.S. as price increases that reflect a reduction in the worldwide supply of oil—unless U.S. exports to these fast growing countries account for a significant share of U.S. output.

Friday, November 11, 2005

The Response of the CPI and Core CPI to Energy Shocks

I'm supposed to be getting ready to present a paper to our macro research group tomorrow. So, to procrastinate and really put the pressure on later, I decided to estimate an impulse response function from a VAR model to answer a question I've been wondering about. What's a VAR model? It doesn't matter. Here's what it does. I wanted to know how long it takes a shock to energy prices to bleed through to core inflation.  So I downloaded monthly data from FRED for 1957:1 through 2005:09 and calculated inflation rates for the CPI, core CPI (CPI less food and energy), and the PPI for energy (PPIENG, the price index for fuels and related power, chosen mainly because it is a longer time-series than other energy indexes). Then, using these three variables I estimated a three lag VAR model and used it to forecast how the CPI and core CPI will change in response to a one-time shock to energy prices. Here's the graph of the results (I'll show results for two lags as well to check robustness, and I also  estimated other lag lengths, checked serial correlation statistics, etc., and  two lags, certainly three, eliminates serial correlation):

The main thing to notice is the delay between the time the shock hits and the subsequent rise in core inflation. For the first month after the shock, the CPI rises, but core CPI rises very little. At the end of two months the effect on core inflation is much larger but the peak effect does not occur until three months after the shock. After the peak at three months, core inflation slowly declines through the end of the year. Remember, the shock to energy prices lasts only one month yet the effects are drawn out over a much longer period of time. The two lag model is similar, but shows a little less persistence and the response of core inflation occurs a bit earlier. But there is still a delay between the response of the CPI and the subsequent response of core inflation.

Okay, enough for now. I should caution that with more time I would want to build a much better model than this. Real variables such as consumption, investment, GDP, and wages might be included and an interest rate, perhaps the federal funds rate, is another candidate variable. There are trend and co-integration issues to worry about, whether to include levels or changes (or both, or gaps) of some variables, I would want to find a better energy index, check robustness to ordering and alternative structural assumptions, ...

Saturday, October 29, 2005

Oil Price Shocks and Inflation

This FRBSF Economic Letter looks at oil prices and inflation and finds that oil price shocks are often assigned too much responsibility for the high inflation of the 1970s because the effects of faulty monetary policy and drifting inflationary expectations are underestimated. Here is a short version of the paper:

Oil Price Shocks and Inflation, by Bharat Trehan, Research Adviser, SF Fed: Oil prices have risen sharply over the last year, leading to concerns that we could see a repeat of the 1970s, when rising oil prices were accompanied by severe recessions and surging inflation. ... This Letter ... argue[s] that oil shocks are sometimes assigned too large a role in the run-up in inflation during the 1970s because analysts tend to ignore the part played by inflation expectations and by monetary policy during this period. The implication is that the recent oil shock should not lead to as much inflation as the 1970s would suggest. Financial markets provide confirming evidence. ... there is little evidence to suggest that markets are expecting substantially higher inflation as a result of the run-up in oil prices since the beginning of the year. As discussed ..., this could be because the markets are expecting the Fed to respond vigorously to the run-up in oil prices. But a look at the fed funds futures markets reveals that markets are not expecting very large policy moves. ... Thus, financial market expectations do not appear to be out of line with the statistical analysis. Markets do not expect the recent substantial rise in oil prices to lead to a substantial increase in inflation, and they expect this result to occur without the kind of funds rate increases one saw in the 1970s...

Jim Hamilton is quoted making similar points. Alan Greenspan views the degree of pass through as an area of considerable uncertainty, but if this research holds up, it implies less pass through of oil shocks to core inflation than commonly assumed, and hence less need for tightening of interest rates to prevent an outbreak of inflation.

[Update: Brad DeLong comments.]

Tuesday, October 18, 2005

Alan Greenspan on Energy

Alan Greenspan discusses oil and energy in this speech given in Japan. The speech covers the days of John D. Rockefeller and Standard oil to the present day, and speculates into the future. He believes the recent rise in oil prices will slow the economy, but with the flexibility and adaptability that market systems provide, and the changes the economy has undergone in response to high oil prices in the past, the rise in oil prices should prove far less costly in terms of both output losses and higher inflation than in the 1970s. As always, he expresses his great faith in free markets as the best solution to economic problems:

Energy, by Alan Greenspan: Even before the devastating hurricanes of August and September 2005, world oil markets had been subject to a degree of strain not experienced for a generation. Increased demand and lagging additions to productive capacity had eliminated a significant amount of the slack in world oil markets ... Although the global economic expansion appears to have been on a reasonably firm path through the summer months, the recent surge in energy prices will undoubtedly be a drag from now on. In the United States, Japan, and elsewhere, the effect on growth would have been greater had oil not declined in importance as an input to world economic activity since the 1970s. How did we arrive at a state ... so fragile that weather, not to mention individual acts of sabotage or local insurrection, could have a significant impact on economic growth? ... The history of the world petroleum industry is one of a rapidly growing industry seeking the stable prices that have been seen by producers as essential to the expansion of the market. In the early twentieth century, pricing power was firmly in the hands of Americans, predominately John D. Rockefeller and Standard Oil. ...  Rockefeller had endeavored with some success to stabilize those prices by gaining control ... of nine-tenths of U.S. refining capacity. But even after the breakup of the Standard Oil monopoly in 1911, pricing power remained with the United States ... Indeed, as late as 1952, crude oil production in the United States ... still accounted for more than half of the world total. ... Of course, concentrated control in the hands of a few producers over any resource can pose potential problems. ...[T]hat historical role ended in 1971, when excess crude oil capacity in the United States was finally absorbed by rising world demand. At that point, the marginal pricing of oil ... abruptly shifted to a few large Middle East producers ... To capitalize on their newly acquired pricing power, many ... in the Middle East, nationalized their oil companies. But the full magnitude of the pricing power of the nationalized oil companies became evident only in the aftermath of the oil embargo of 1973. ...[and the] ...  further surge in oil prices that accompanied the Iranian Revolution in 1979... The higher prices of the 1970s abruptly ended the extraordinary growth of U.S. and world consumption of oil and the increased intensity of its use ... In the United States, between 1945 and 1973, consumption of petroleum products rose at a startling average annual rate of 4-1/2 percent, well in excess of growth of our real GDP. However, between 1973 and 2004, oil consumption grew ... at only 1/2 percent per year... Much of the decline in the ratio of oil use to real GDP in the United States has resulted from growth in the proportion of GDP composed of services, high-tech goods, and other presumably less oil-intensive industries. Additionally, part of the decline in this ratio is due to improved energy conservation ... These trends have been ongoing but have likely intensified of late with the sharp, recent increases in oil prices... [T]he story since 1973 has been as much about the power of markets as it has been about power over markets. ... The failure of oil prices to rise as projected in the late 1970s is a testament to the power of markets and the technologies they foster. Today, the average price of crude oil ... is still in real terms below the price peak of February 1981. Moreover, since oil use ... is only two-thirds as important an input into world GDP as it was three decades ago, the effect of the current surge in oil prices, though noticeable, is likely to prove significantly less consequential to economic growth and inflation than the surge in the 1970s...

[T]he opportunities for profitable exploration and development in the industrial economies are dwindling, and the international oil companies are currently largely prohibited, restricted, or face considerable political risk in investing in OPEC and other developing countries. In such a highly profitable market..., one would have expected a far greater surge of oil investments. ... But because of the geographic concentration of proved reserves, much of the investment in crude oil productive capacity required to meet demand, without prices rising unduly, will need to be undertaken by national oil companies in OPEC and other developing economies. Although investment is rising, ... many governments perceive that the benefits of investing in additional capacity to meet rising world oil demand are limited. ... Unless those policies, political institutions, and attitudes change, it is difficult to envision adequate reinvestment into the oil facilities of these economies. Besides feared shortfalls in crude oil capacity, the status of world refining capacity has become worrisome as well. ... A continuation of this trend would soon make lack of refining capacity the binding constraint on growth in oil use. This may already be happening in certain grades... [T]he expansion and the modernization of world refineries are lagging. For example, no new refinery has been built in the United States since 1976. ... Much will depend on the response of demand to price over the longer run. If history is any guide, should higher prices persist, energy use over time will continue to decline relative to GDP. ... With real energy prices again on the rise, more-rapid decreases in the intensity of energy use in the years ahead seem virtually inevitable. Long-term demand elasticities over the past three decades have proved noticeably higher than those evident in the short term...

Altering the magnitude and manner of energy consumption will significantly affect the path of the global economy over the long term. ... We cannot judge with certainty how technological possibilities will play out in the future, but we can say with some assurance that developments in energy markets will remain central in determining the longer-run health of our nations' economies. The experience of the past fifty years ... affirms that market forces play a key role in conserving scarce energy resources, directing those resources to their most highly valued uses. However, the availability of adequate productive capacity will also be driven by nonmarket influences and by other policy considerations. To be sure, energy issues present policymakers with difficult tradeoffs to consider. The concentration of oil reserves in politically volatile areas of the world is an ongoing concern. But hopes ... that ... does not distort or stifle the meaningful functioning of our markets. Barring political impediments to the operation of markets, the same price signals that are so critical for balancing energy supply and demand in the short run also signal profit opportunities for long-term supply expansion. Moreover, they stimulate the research and development that will unlock new approaches to energy production and use that we can now only barely envision. Improving technology and ongoing shifts in the structure of economic activity are reducing the energy intensity of industrial countries ... If history is any guide, oil will eventually be overtaken by less-costly alternatives well before conventional oil reserves run out. Indeed, oil displaced coal despite still vast untapped reserves of coal, and coal displaced wood ... New technologies to more fully exploit existing conventional oil reserves will emerge in the years ahead. ... We will begin the transition to the next major sources of energy, perhaps before midcentury, as production from conventional oil reservoirs ... is projected to peak. In fact, the development and application of new sources of energy, especially nonconventional sources of oil, is already in train. Nonetheless, the transition will take time. We, and the rest of the world, doubtless will have to live with the geopolitical and other uncertainties of the oil markets for some time to come.

Friday, October 07, 2005

Krugman: A Pig in a Jacket

Paul Krugman takes a look at the administration's sudden support of energy conservation. He starts by recalling Dick Cheney's rejection of energy conservation during the California energy crisis and notes the recent about face by energy secretary Samuel Bodman on this issue:

A Pig in a Jacket, by Paul Krugman, NY Times: ...[T]his week Samuel Bodman, the energy secretary ... declared that "the main thing that U.S. citizens can do is conserve." Is the Bush administration going green? No, not really.

Then why the sudden switch to encourage conservation?

The background to Mr. Bodman's remarks is growing public anger over ... the price of gasoline, but the worst is yet to come: just wait until people see their winter heating bills, especially for natural gas ... the political danger to the administration is obvious: polls suggest that many people blame... administration for failing to control price gouging.

Krugman notes that during the California crisis, hardly anyone would believe prices were manipulated, though later it was confirmed that they were, whereas this time it is widely believed that prices are being manipulated when there is no evidence of that happening:

Now, much of the public believes that corporate evildoers with close ties to the administration are conspiring to drive prices up. But this time they aren't, at least so far.

Paul Krugman defending energy companies? Wow!

Just in case you think I've gone soft on the energy industry, let me say that claims that we're having a crisis because environmentalists wouldn't let oil companies do their job are equally bogus... the current crisis is nobody's fault, except Mother Nature's.

Krugman notes that until recently, energy companies weren't interested in building refineries because there was no expected profit in doing so, not because of environmental regulations. With respect to the current crisis, when the supply of a product like energy falls, we need to find a way to reduce demand from its previous levels. Krugman calls this "demand destruction" and notes it is needed to bring demand in line with the reduced supply. But how is this accomplished?

In the absence of an effective conservation policy, prices will do all the persuading: the cost of fuel will rise until people drive less and turn down their thermostats. The problem, of course, is that high prices will impose serious hardship on many families.

And that hardship could mean political trouble, hence the sudden shift to push conservation. But, says Krugman,

[A]s you might expect, the administration's conservation push lacks conviction.... the administration's attempt to promote "Energy Hog," a cartoon pig in a leather jacket, as a conservation mascot verges on the pathetic. So it's going to be a long, cold winter...

The short-run is looking chilly and expensive. What about the longer run?

The long-term case for energy conservation doesn't have much to do with the current shortages. Instead, it's about national security, broadly defined - reduced dependence on Middle East oil supplies, reduced emission of greenhouse gases.

National security? Those are magic words. Will that get the job done?

No such luck: when it comes to substantive actions, as opposed to public relations, it's still the same old, same old. Mr. Bush has ... said nothing about raising mileage requirements and efficiency standards for appliances. And as for a higher gasoline tax, which would be politically possible only with broad bipartisan backing - don't be silly. Conservation's day will come. But it hasn't happened yet.

Wednesday, September 21, 2005

Thomas Friedman: Use Gas Tax to Move the U.S. Toward Energy Independence

My fourteen day free trial of Times Select uncovered Thomas Friedman of the NY Times beating the drum, as he has in the past, for the administration to do more to move the U.S. toward energy independence.  I agree with his conclusion - don't get your hopes up:

Bush's Waterlogged Halo, by Thomas Friedman, NY Times: Following President Bush's speech in New Orleans, many U.S. papers carried the same basic headline: "Bush Rules Out Raising Taxes for Gulf Relief." The president is planning to rely on "spending cuts" instead to pay for rebuilding New Orleans. Yeah, right - and if you believe that, I have some beachfront property in Biloxi I'd like to sell you. The underlying message of all these stories is that the Bush team sees no reason to change course in response to Katrina.

I beg to differ. Katrina deprived the Bush team of the energy source that propelled it forward for the last four years: 9/11 and the halo over the presidency that came with it. The events of 9/11 created a deference … That deference is over. If Mr. Bush wants to make anything of his second term, he'll have to do his own Nixon-to-China turnaround, reframe the debate and recast the priorities of his presidency. He seems to think that by offering to spend billions of dollars to rebuild one city, New Orleans, he'll get his leadership halo back. Wrong. Just throwing more borrowed money at New Orleans is not leadership. Mr. Bush needs to frame a new agenda ... And what should be the centerpiece of a policy of American renewal is blindingly obvious: making a quest for energy independence the moon shot of our generation. The president should have done that on the morning of Sept. 12, 2001. The country was ready. But the president whiffed. Katrina - nature's 9/11 - has given him a rare do-over. Imagine - I know it is a stretch - that the president announced tomorrow that he wanted an immediate 50-cents-a-gallon gasoline tax - the "American Renewal Tax," to be used to rebuild New Orleans, pay down the deficit, fund tax breaks for Americans to convert their cars to hybrid technology or biofuels, fund a Manhattan Project to develop alternatives for energy independence, and subsidize mass transit systems for our major cities. And imagine if he tied this to an appeal to young people to go into science, math and engineering for the great national purpose of making us the greenest nation on the planet, to help liberate us from dependence on the worst regimes in the world for our oil …

Americans will change their long-term energy habits, and companies will develop green products, only if they are certain the price of gasoline will not go back down. A gasoline tax … and stronger regulation would force U.S. companies to innovate in what is going to be one of the most important global industries in the 21st century: green technologies. By coddling our auto and industrial companies when it comes to mileage standards and the environment, all the Bush team is doing is ensuring that they will be dinosaurs and that Chinese, Japanese and Indian companies will take the lead in green technologies … Look what Jeff Immelt, the C.E.O. of G.E., said: "America should strive to make energy and environmental practices a national core competency and by doing so, create exports in jobs. ..." Setting the goal of energy independence, along with a gasoline tax, could help to solve so many of our problems today - from the deficit to climate change and national security. And Americans would pay it if they thought the extra money was going to renew America, not Iran, and not just New Orleans. And if the Texas-oilman president became the energy-independence president - now, that would snap heads and make this a truly relevant presidency. No way, you say. Probably right. But either Mr. Bush does a Nixon-to-China or his next three years are going to be a Bush-to-Nowhere.

Thursday, September 08, 2005

Truth in Advertising

Let's see, 14.2 gallons at OMG 9/10 is how much?:

The White House Tells Refiners to Skip Scheduled Maintenance

The White House, signaling it does not trust the free market to provide the correct production incentives, tells refiners to put off scheduled maintenance in order to maximize output in the short-run, a strategy that could cause problems down the road:

Bush calls for fuel output boost, Financial Times: The White House has told US refiners to postpone all scheduled maintenance in a drive to maximise petrol and diesel production as the administration raised its oil price forecasts on Wednesday in the wake of Hurricane Katrina... Washington has also told refiners to stop producing ultra-clean diesel to increase petrol output.

Continue reading "The White House Tells Refiners to Skip Scheduled Maintenance" »

Wednesday, August 10, 2005

Iraq Fuel Subsidies Create Thriving Black Market and Shortages

Iraq provides a good lesson on the problems that occur when prices are fixed at non-market clearing levels through government intervention.  Subsidized fuel in Iraq costs the government nearly seven billion dollars, a figure representing over a quarter of Iraq’s GDP, and cause classic problems such as black market activity and shortages:

Continue reading "Iraq Fuel Subsidies Create Thriving Black Market and Shortages" »

Saturday, June 25, 2005

Does the Increase in the Price of Gold Signal Inflationary Expectations are Rising?

You might find this interesting.  Speculators are dumping dollars and moving into real assets such as gold and a few analysts are predicting the price to nearly double over the next few years.  Possible reasons?  Higher inflationary expectations, flight out of real estate funds due to fears the peak is near, and flight out of hedge funds.  Another factor, according to this article,  appears to be Middle Eastern nations increasingly holding real assets such as gold in their portfolios rather than dollar denominated paper assets to avoid currency risk:

Gold rush may mean inflation bust - The metal's recent jump worldwide and high oil prices signal serious inflation pressures ahead, by Katie Benner, CNN/Money:  Gold rising along with the dollar -- and with oil jumping to record highs near $60 a barrel -- may signal serious inflation woes ahead. … A handful of precious metals insiders … predicted that the price of spot gold will hit $850 an ounce in the next few years from its current level near $440.  The last time it got anywhere near that high was in the late 1970s when out-of-control inflation, unrest in the Middle East and an oil crisis pushed the precious metal from $150 to $810 a troy ounce.  Gold is currently trading 30 percent above its 10-year moving average … and gained five percent this month … While economists debate whether high oil prices will spark inflation or will slow economic growth by acting as a tax on consumers and businesses, the gold and bond markets have come down on the side of inflation.  "The recent run in gold has moved in conjunction with rising crude prices," David Meger, senior metals analyst at Alaron Trading, said in a recent note.  ...  "Middle East nations are getting more petrol dollars as (oil) prices rise, and they're not putting it back into paper assets," said Charles de Vaulx, manager of the First Eagle Gold Fund. "They're trying to protect the value of their profits -- just like in the 1970s -- so they're buying gold," he … despite the fact that some market analysts … say the metal has become overbought in the short term.  … When inflation grips a market, the value of dollar-denominated assets is eroded. So a shift to gold represents … a broader shunning of financial assets in favor of hard assets as a hedge against perceived currency risks. …  At the moment, however, gold and the dollar are both rising. But metals traders argue that the price of gold is still an accurate indicator of inflation risks, because the dollar's rise doesn't reflect true strength, only relative value compared to an equally troubled currency.  "Confidence in the euro as an alternative to the dollar has fallen apart," said Frank Holmes, chairman and chief investment officer as U.S. Global Funds. … Few analysts believe the metal will trade between $600 and $800 over the next few years, mostly because they assume rising oil prices will slow demand for fuel and eventually bring crude prices down.  But consulting firms like Alaron Trading are still bullish on gold, particularly because they see weakness in a variety of paper assets. …"We're seeing both real estate and hedge fund become more uncertain now, and if it's going to happen, we'll see the investment demand for gold," de Vaulx said.

I don’t believe we will see significant inflation – the Fed will not let that happen – so I would not place as much emphasis as this article does on inflation fears as an explanation for the flight into gold.  But feel free to disagree ...

Real and Nominal Oil Prices Since 1970

The Wall Street Journal has a nice graph of real and nominal oil prices since 1970 highlighted with important historical events.  Click here to take a look.

Thursday, April 21, 2005

Oil Futures Rise Slightly On Inventory Data

Crude oil futures rose slightly earlier today after the release of data showing falling domestic inventories of oil and gasoline. In addition, there are mixed signals about OPEC's ability and willingness to increase supply to stabilize prices. The secretary-general of OPEC says production will be increased as necessary to stabilize prices, but Qatar's oil minister says that production is already near maximum:

Oil prices rise on inventory data
The Associated Press
Updated: 3:53 p.m. ET April 20, 2005

Crude futures rose slightly Wednesday after U.S. government data showed declining domestic inventories of oil and gasoline…Global oil reserves are in little danger of drying up for many decades, an OPEC senior official said Wednesday, and the Organization of Petroleum Exporting Countries will keep raising production as needed to stabilize prices.

“The problem in 2004 was we did not anticipate the strength of demand ... it appears that in 2005 we are reaching a plateau,” said Adnan Shihab-Eldin, acting secretary-general of the OPEC.

Unusually high prices cannot continue forever, “as long as you continue to put greater supply in the market,” he said.

Meanwhile … Qatar’s oil minister … said that global oil inventories were strong, with more in the market than OPEC had expected. Although he said it was too early to predict what OPEC will do at its June meeting … the organization … was unlikely to increase production at its June meeting in Vienna.

“I believe today the market’s very, very balanced,” he said. “The inventory today is the highest since 2002. So it means there’s more oil in the market than we expected.”

Al Attiyah also stressed that OPEC members have little room to increase production. “OPEC is almost producing to the maximum,” he said. “In a few countries they have spare capacity, but in most member countries they have no spare capacity.”

He also indicated that oil prices should ideally be between $40 and $50 a barrel…