Topic: Energy and Environment

Blame OPEC? Not So Fast!

In today’s Washington Post, columnist Robert Samuelson blames OPEC for the 2003-2008 oil price spiral in an arresting column titled OPEC’s Triumph. Color me skeptical.

Samuelson says that the beginning of the price surge can be traced back to early 1999, when oil prices were around $10 a barrel. OPEC and major non-OPEC producers in Norway, Mexico, and Russia jointly agreed to “cut production sharply,” Samuelson reports, and subsequent compliance with those output quotas was “surprisingly good.”

Well, let’s go to the data (specifically, data from the Energy Information Administration found here and here). In 1998, oil production in OPEC (minus Angola) plus the “Big Three” non-OPEC members mentioned by Samuelson was on average 43.6 million barrels per day (mbd). In 1999, aggregated production from those parties did indeed drop by about 1 mbd, but in 2000, production from the same shot up by 2.5 mbd and remained steady in 2001 (45 mbd). Production in 2002 dropped by about 1.5 mbd, but then jumped by 2.6 mbd in 2003; 3 mbd in 2004, and 1.4 mbd in 2005 before dropping back by 0.5 mbd in 2006.

So at best, we have some evidence that the producer agreement flagged by Samuelson had the desired effect in 1999 – if not necessarily thereafter. But even that’s unclear. Oil markets were so soft in 1999 that plenty of “non-conspirators” cut oil production that year as well. Canada, for instance, went from 2.7 mbd in 1998 to 2.63 mbd in 1999 before jumping back up to 2.75 mbd in 2000. The United States exhibits the same pattern; 9.28 mbd in 1998, 8.99 mbd in 1999, and 9.06 mbd in 2000. Many smaller “price takers” unaffiliated with any cartel made the same production decisions. Australia, for instance, went from 649,000 barrels a day (bd) in 1998 to 647,000 bd in 1999 and 828,000 bd in 2000.

If post-1999 OPEC decisions were truly constraining global crude oil supply, we should see an increasing amount of unused production capacity lying idle in those countries. But we don’t. While the true amount of unutilized production capacity is hard to estimate confidently, industry watchers seem to agree that it is going down, not up. Producers don’t seem to be holding any light crude oil back at all (the most valuable kind to the market) and what they are holding back (very heavy sour crudes) is hard to sell. That doesn’t square with a story about how recent decision-making by OPEC is responsible for starving the market and inflating price.

If OPEC is to blame for all of this, the blame rests on cartel members who haven’t invested as much in production capacity as they might have absent membership in the same. But it takes a long time for investment in new production capacity to yield substantial amounts of crude oil – sometimes as much as 8-10 years. And given the prices of a decade ago (the lowest inflation adjusted prices in recorded history), it’s hard to blame the cartel for a lack of investment from 1999-2003. Even non-cartel members were uninterested in substantial investments in production capacity back then.

Now, none of this is to rule out Samuelson’s hypothesis out of hand. Production costs are so low in OPEC (they are widely thought to be less than $5.00 a barrel in Saudi Arabia), that one could argue that any profit maximizing economic actor not caught up in price-fixing operations would have invested a lot more money in production capacity than we’ve seen in the Persian Gulf to-date. But there are alternative explanations out there for this lack of investment. Maybe “cheap oil” is indeed running out. Maybe domestic political considerations are frustrating investments (these are state-owned oil companies after all). Maybe marginal production costs outside of Saudi Arabia are a lot steeper than many analysts realize. Maybe it’s not the cartel per se that’s constraining production; maybe it’s the unilateral exercise of Saudi market power under the cartel’s cover that’s to blame. It’s worth noting that academics have studied OPEC for decades and are still unable to find hard evidence that the cartel has indeed given us higher crude oil prices than would have been given us in an alternative world without OPEC.

Interestingly enough, the chief source for Samuelson’s column – oil economist Philip Verleger – doesn’t buy Samuelson’s argument. Verleger thinks that the increasing demand for oil securities as a hedge against volatility in equity markets and the weakening dollar explains the bulk of the price run-up between 2003-2007 and that the United States government – via its insane buy-orders for the SPR – is largely responsible for the near-doubling of oil prices since last August.

There are, of course, alternative explanations out there, but none of them fit comfortably with the data. And that’s what makes oil markets so interesting to watch these days – nobody can be completely sure exactly what is going on. Samuelson’s explanation, however, is somewhat less convincing than most.

Bush to Congress - Unhand that Candy!

Last week, the House passed an energy tax bill that would dole out some $18 billion worth of renewable energy tax breaks. To pay for it, they would increase taxes (advertised falsely as eliminating equivalent tax breaks) to the same degree on everyone’s favorite kicking-post, “Big Oil.” The bill is now in the Senate, and most observers doubt that the latter aspect of the bill will survive.

Okay, so what does the adminstration say about this? Andy Karsner, assistant secretary for energy efficiency and renewable energy at the DoE, sticks to the standard administration script - he wants the spending but not the taxing. At an energy conference hosted by the administration today, Greenwire (subscription required) reports that he said, “Stop holding the ‘candy’ hostage to political arguments and games and distractions!”

So this is what conservative Republicanism has come to. Corporate welfare (at least, some corporate welfare) is candy. Subsidies are, presumably, akin to chocolate. Well, if so, then it’s time for these guys to go on a diet. Better yet, it’s time for these guys to get out of town. Let’s take away everyone’s candy and call it a day.

Flex-Fuel Nonsense

Over at National Review Online today, Clifford May asks:

What if lawmakers could guarantee that the price you pay to fill your car’s tank will go down, not up, in the years ahead? What if they could launch a new industry that creates more jobs for more Americans? What if this would produce environmental benefits, too? Would that not send a message to the markets? And would that not represent the kind of change so many politicians have been promising?

All of this would come true, Mr. May believes, if the federal government would force auto makers to ensure that every new car sold in the United States could run on gasoline OR high blends of ethanol OR methanol OR fill-in-the-blank. After all, it would only cost about $100 up-front during the manufacturing process to make such “flex-fueled” cars a reality, a modest investment that would give motorists a ready-made ability to run their cars on whatever strikes their fancy.

Well, to answer Mr. May’s questions in the order they are posed, they can’t, they won’t, it wouldn’t, it would, and it wouldn’t.

Congress can no more guarantee that fuel prices will go down from now until the end of time than it can guarantee a robust sex life for fat, balding, middle-aged men. Fuel prices are subject to supply and demand curves that do not answer to Congress — particularly in global energy markets.

The conceit that government can create jobs by creating industries out of whole cloth glosses over the fact that the money needed to create those industries and those jobs starves other industries of cash that will, in turn, eliminate other jobs. While it’s not inconceivable that government could on balance create more jobs than it destroys in this manner (that is, that the industry created is more labor-intensive than the industries harmed), that’s still not a good reason to go forward. After all, one might on balance increase employment in the United States by banning modern farm machinery and food imports, which would put a lot of people into the fields. But no sane person would endorse such a thing on economic grounds. Economic growth occurs when we increase productivity, and we don’t necessarily do that by biasing investment toward labor-intensive activities.

Promoting alternative fuels is not necessarily good for the environment. Ethanol, for instance, increases urban smog without any corresponding reduction in greenhouse gas emissions. It drains already depleting groundwater reserves and pollutes those that remain. It puts millions of additional acres of land under the plow, which in turn kills ecosystems and further pollutes navigable waterways. In short, gasoline looks positively “Green” compared to many of the fuels Mr. May hopes to champion.

Mr. May is correct, however, about the fact a mandate like this would send a message to the markets. The message would be “Congress is not a serious legislative body.” But to be fair, it’s not as if the market hasn’t heard that message before.

Mr. May is wrong, however, to think that a flex-fuel mandate would represent the kind of “change” that most politicians are promising. Congress has told Detroit how to build its cars for decades now. Nothing new there.

The main reason that this sales pitch is hollow, however, has to do with the fact that, at present, there is no cheap alternative to gasoline. The problem isn’t that cars can’t use the fuel. The problem is the cost of the fuel. For instance, on wholesale spot markets as of Jan. 24, 87 octane was selling at $2.32 per gallon. Compare that to the price for alternative fuels (in the same spot wholesale markets) once you adjust for the differences in energy content:

• E100 ethanol — $3.53 per gallon
• B100 biodiesel — $3.97 per gallon
• Methanol — $4.22 per gallon

In short, there’s a good reason why auto companies aren’t popping flex-fuel capabilities into every engine sold: consumers don’t seem willing to spend the $100 extra for that extra. Well, to be precise, most consumers don’t seem that interested. Some are in fact buying flex-fueled vehicles right now — 4 million such vehicles are thought to be on the road at present and dozens of models are on sale right now. But some of us aren’t willing to fork over the extra money for the option to use those fuels over the lifetime of our new car.

Should Congress override consumer preferences in that regard? No. Given the high cost of alternatives, consumers are not acting irrationally when they say “no thanks” to flex-fueled vehicles.

Would auto companies be advantaged by a flex-fuel mandate? Mr. May thinks so, but auto executives tend to disagree. My guess is that Mr. May knows less about their business than they do.

If and when alternative fuels are cheaper than gasoline, you can rest assured that consumers will increase their demand for flex-fueled vehicles and that auto makers will supply them out of simple interest in profit. Government mandates are not necessary.

Ethanol Program Milks Consumers Dry

Have you noticed how the price of milk has shot up in the past year? A big chunk of the blame lies with Congress and the ethanol program.

In its effort to promote the fantasy known as “energy independence,” the U.S. Congress favors the ethanol industry with a 51-cent-per-gallon exemption from the federal gasoline tax, and a 54-cent-per-gallon tariff on imported ethanol. By artificially stimulating the domestic ethanol industry, the program has created an insatiable demand for corn, driving up feed grain costs for dairy farmers, leading to higher prices for milk.

I’ve often disagreed with Sen. Chuck Schumer (D-N.Y.) on trade issues, especially his threat to slap tariffs on imports from China, but on this issue, the senator has positioned himself as the American consumer’s best friend. According to a story this week in the New York Daily News:

“Ethanol has increased the average American’s grocery bill $47 since July,” said Sen. Chuck Schumer, citing figures from Iowa State University.

Schumer (D-N.Y.) is pushing for an immediate end to the 54-cent-per-gallon tariff on ethanol imports as a way to increase the supply of the federally mandated fuel additive, reduce pressure on the corn market and bring down milk prices.

“Bring the cheaper ethanol in, reduce the price of corn, and then reduce the price of milk,” he said.

The senator is on to something. While were at it, let’s eliminate remaining U.S. tariffs on imported shoes, clothing, sugar, rice, cheese and, yes, milk.

Energy Price Controls in China

From our “never thought I’d live to see the day file,” Chinese Prime Minister Wen Jiabao announced yesterday that China would freeze energy prices as a means of combating inflation and appeasing public anger over escalating fuel prices. Well, been there, done that. If past is prologue, don’t expect a happy ending to this story.

Intellectual Honesty and Oil Prices

During the GOP presidential debate Saturday night, moderator Charlie Gibson - anchor of ABC’s World News Tonight - asked the candidates whether “intellectual honesty” demanded that they forthrightly tell the American people that oil prices were only going to get higher? None of the candidates really answered the question, so allow me to do so.

No.

Oil prices might indeed be on a rocket ship upwards for as far as the eye can see, but market actors don’t think so. At the New York Mercantile Exchange, oil for delivery from next month through December 2016 is showing a downward price trend. In short, the people with the most money on the line - who will live and die (economically speaking) by these assessments - aren’t buying Gibson’s assertion about the future.

More evidence can be found the behavior of oil inventory holders. At present, oil inventories are being released to the market –hardly what one would expect if inventory holders thought that oil prices will continue their long march upward.

Of course, market actors could be wrong. Energy forecasts have such a poor track record that one should probably resist making any concrete predictions about the future. So while Charles Gibson might well be right that oil prices are only going to go higher, it is not “intellectually dishonest” to suggest that might not be the case.

$100 Oil

One of the big stories today is news that oil deliveries for February topped $100 for the first time in history yesterday and are again over $100 today. Lots of ink has predictably been spilled covering this story, but it’s unclear why. The $100 threshold is purely psychological and holds little import to the market. The macroeconomy is hardly more affected by $100 oil than it is by $98 oil. Likewise, the great public hunt for the “tipping point” at which oil price increases induce significant changes in consumer behavior is akin to Captain Ahab’s hunt for Moby Dick. Since oil prices began their run up in 2003, demand has remained relatively strong and consumers have responded far less robustly than they did during the price run-up from 1975-1980. Although it is unclear why consumers are so much less inclined to conserve fuel today than they were yesterday, there is little reason to expect any radical change in consumer response to fuel price increases in the short term.

The more interesting question is why oil prices have risen so dramatically since August of last year – one of the three or four largest price increases of the last 30 years. The standard explanations – turmoil in oil producing regions, demand growth in India and China, global crude oil shortages, speculation, and low oil inventories – are not very satisfactory. Turmoil in oil producing regions has, if anything, declined since August. Demand growth in India and China is hardly a new phenomenon. Oil production in the 3rd quarter of 2007 actually increased (4th quarter data is not yet in) and Middle Eastern producers are increasing discounts available to buyers of heavy crude. Oil inventories are likewise being liquidated - hardly a sign that speculators are hoarding oil to drive up price.

The only significant change in world crude oil markets has been the buy orders coming out of the United States for crude oil destined for the U.S. Strategic Petroleum Reserve. Oil economist Philip Verleger believes that most of the recent price movement can be traced to that fact alone, although the evidence for that proposition is not dispositive.

Regardless, there is little reason to succumb to panic. First, there is strong empirical evidence to suggest that consumers invest efficiently in automotive fuel efficiency. Hence, long-run demand response may prove much more robust than short-run demand response. Second, the economic burden of high gasoline prices today is greatly overstated relative to what that burden has been in the past given the increases in per capita and median household income. In fact, the “hardship price” of gasoline (that is, gasoline prices adjusted for inflation and changes in household income) is about average what it has been since the end of World War II. Third, belief that high oil prices are important macroeconomic events that are capable of triggering recessions or worse have been shattered by recent experience. Fourth, the fact that inventories are being released - not built up - tells us that market actors are betting that today’s high prices are not long for this world.

Taken together, those observations imply that government should treat high oil prices with benign neglect. If consumers want to reduce their fuel bills, there are ample opportunities available for them to do so. A good rule of thumb - even for non-libertarians - is that government should not do for you what you can do for yourself.