This is the first post in a series where I will examine common misconceptions and misunderstandings about energy supply, consumption, and pricing. In subsequent posts I will deal with the myth of American oil independence, why shale oil like the Bakken play is over-hyped, and why natural gas shale like the Marcellus is really over-hyped.
First, let's examine the concept of high price. High compared to what? I'm fond of telling people that gasoline is remarkably cheap -- one of the few bargains available to us. I remind them that I can buy a litre of gas for $1.22 Cdn (Mar. 3, 2012) which will take me at least 10 km (28.3 Imperial mpg, 23.5 U.S. mpg). If I gave them $1.22, could they find some cheaper way of getting me 10 km down the road at 100 km/hr, carrying assorted personal effects, and perhaps 3 or 4 passengers, radio playing, interior climate controlled with heat or air conditioning? No-one has been able to give me a substitute, other than buying an electric car which might offer a lower operating cost, although with a much higher vehicle cost.
Second, let's examine the real (inflation adjusted) price of gasoline. Data from gasbuddy.com today shows average US price for regular gas to be $3.72. The chart from inflationdata.com below shows the historical cost of US gas, priced in January, 2012 US dollars. (Click chart and any other in this blog for sharper image.)
Gasoline is now almost exactly the same price as it was in 1918, adjusted for inflation. People tend to use changes in nominal prices (the black line in the above chart), but it is the real (inflation adjusted) price that counts. Note that current prices aren't much above the 1981 average price of $3.37.
Back in the 1960s we could slide across to the American side and buy 3 US gallons of gasoline for a dollar, either paper or silver. The silver dollars contained 0.7734 ounce of silver, roughly 3/4 of an ounce. In other words, an ounce of silver in the 1960s would buy about 4 gallons of gas.
With silver currently priced at $35/oz, those silver dollars would be worth 0.7734 x $35 = $27.07 melt value. With gasoline presently at $3.72/gal, those silver dollars should buy 7.28 gallons and an ounce of silver would buy 9.40 gal. Gas is much cheaper today than in the 1960s, when priced in silver! What has happened is that the value of the US paper dollar has been seriously depreciated, increasing the cost of things priced in US dollars.
If a silver dollar today is worth 7.28 gallons of gasoline, then one gallon of gasoline should cost 1/7.28, or .1374 of a silver dollar (13.74 cents). That's why this guy is making big profits selling gas at 20 cents per gallon, priced in silver coins!
As a third consideration, let's examine what components contribute to the price of gasoline at the pump. There are several good images in this linked short article, including the one below comparing Canadian and US prices. Obviously tax is the biggest component contributing to price differences. The chart in the article showing prices around the world is useful to show how low Canadian and US prices are relative to other countries.
In the US the federal government levies a gasoline tax of 18.4 cents per gallon (4.9 cents/litre), which has been unchanged since 1993. That tax would have to be raised to 28.9 cents/gal today to provide the same inflation adjusted revenue that it raised in 1993. But such an increase is impossible in a nation where the citizenry suffer from a mass delusion of over-taxation.
Most people are aware that gasoline prices tend to rise in the spring, stay high over summer, and then decline until the next spring, as shown in various seasonal price charts. Many people think it's a plot to deprive them of their money during the time they tend to drive most (May long weekend through Labour Day). However part of the price increase should be apparent. If they are driving more, so is everyone else; increased demand for any commodity normally results in increased cost. The chart below shows how gasoline demand varies through the year.
Note how gasoline consumption has declined since 2006-2007. Starting in 2007, as Wall Street firms began imploding, I received stupified looks from people when I told them that Americans would never again burn as much gasoline as they did at the height of the housing bubble. A credit collapse is long lasting, and Americans (as well as members of all OECD nations including Canada) will use less gasoline as their economic condition deteriorates. As the earning capacity of developing nations grow, they will consume more and we will consume less of a resource that probably is at or near peak production. I will deal with the concept of peak oil in a subsequent blog.
It should be noted that gasoline consumption per capita in the US peaked around 2000, and has dropped significantly since. The below chart from Doug Short of dshort.com illustrates the trend.
Recent data shows gasoline sales dropping off fast, so when Mr. Short updates this chart the per capita consumption should continue down at an increased rate. It remains to be seen what happens in the future, but I maintain US gasoline consumption is unlikely to ever again reach the levels of 2006-2007. You can't buy what you can't afford unless someone extends credit, and Americans used up their credit during the housing bubble, as did people in most other developed nations.
One consequence of decreasing gasoline consumption in developed nations is pressure on refinery profit margins. As a result some refineries are closing, such as Petroplus in Europe and some refineries supplying the US New England states. There are also complications getting the right amount of the right kind of crude to the right refineries. Each refinery is designed to handle a specific oil blend; one designed for light sweet crude cannot process heavy sour crude, for instance. At the same time as New England refineries close, the mid-west refineries in the US are making out like bandits as they process a surplus of cheaper land-locked Bakken shale oil and Alberta diluted bitumen.
Of course the developing nations are increasing the number of refineries as their citizens and industries start ramping up fuel consmption.
Getting back to the causes for the rise in gasoline prices in the spring, in addition to increased demand, there is also the seasonal change in blend. In the winter the gasoline blends allow for a higher Reid vapor pressure. This allows the blend to hold more of the less expensive ingredients such as butane. In the summer the fuel has less butane, so more of the higher alkanes are used at higher cost of production.
So, you being a rather astute person who is observant of details (if not you wouldn't have read this far), point out that the gas price has gone up early this year, before spring. What gives? Surely that proves oil company price fixing or Wall Street speculation or Obama not allowing drilling, or some combination, right?
Wrong! One factor which many people have trouble accepting is that world crude oil production may have peaked and may be incapable of future increases except on a very short term basis. This is a very controversial issue (peak oil) which I will deal with in a subsequent post. It is clear that most countries are producing at or near maximum capacity, and any disruption (or potential disruption) of supply causes prices to rise.
Which brings me to the second factor. As long as the US military and its puppet tag-alongs in NATO (including Canada) continue to lurch around the world like Cujo, the rabid dog in one of Stephen King's novels, you can expect oil prices to be higher than they would be under calmer circumstances. Probably $10-$20 higher (my guess), and possibly much higher than that if Iran is next after Syria after Libya on the hit list.
A third factor are the central bankers of the world, primarily American and European. As they continue a policy of virtually non-existant interest rates and repetitive emergency bailouts of the banks under their care, they push cash into risk assets and away from savings. Some of that cash moves into commodities of all types, including oil. This is what the average person thinks of as speculation.
In the investment sector there is a long standing fear of the "bond vigilantes". If a nation abuses its credit, then investors will decline to purchase its bonds. Ask Greece. But I have a theory that the commodity vigilantes are more important. As a nation abuses its credit, usually accompanied by devaluation of its currency, the prices of commodities in that currency rise, slowing or reversing the artificial economic growth the central bank and government are trying to achieve. The commodity vigilantes would be more than happy to invest in commodities rather than bonds in that environment and still profit as the general economy stagnates.
If anyone thinks gasoline prices do not follow crude oil prices, they should check out the chart below. Brent crude is used because it is a better reflection of world oil price than the American West Texas Intermediate Crude (WTI) traded on the NYMEX. It is just another example where American influence is waning.
There is a fourth factor influencing oil prices, and thereby gasoline prices. That is political uncertainty. No-one knows what the dysfunctional American government will do about anything, including the energy sector. So short term planning in the energy sector is difficult and long term planning is next to impossible. Look at the political gyrations surrounding the Keystone XL pipeline. All the delays and uncertainties around energy policy results in increased costs to the consumer. Of course the politicians creating the most disruption like to blame "speculators" or "oil producing countries who don't like us very much" or each other based on party lines.
Now let's look at one factor that is not causing a rise in North American gas prices, a failure to drill. Sarah Palin was credited with the "Drill, baby, drill!" mantra when she joined John McCain as the Republican ticket for the Whitehouse in 2008. Of course Obama took over on January 20, 2009. So then the chant turned to "Obama won't let us drill!"
Well, of course. That has to be the answer. I hear it on American right wing media every day. Obama won't let anyone drill; it's a dirty Kenyan communist plot. If only there was some way to check out the numbers of drill rigs over time to confirm the death of drilling. Oh, wait, here's a chart that does that (green additions on the chart are mine).
From the above chart you can see a rise in gasoline prices to an all time high, derived from a similar rise in oil price from 2007 into mid-2008. (I presume it was caused by Bush 43 disallowing drilling.) The number of oil rigs ramped up from the 300 range to about 400. Then gasoline prices crashed as the recession hit, and after a few months lag the oil rig count dropped to less than 300. Near the end of 2008 gasoline prices started back up but rigs continued down into spring of 2009, bottoming under 200. Then they turned and followed oil and gasoline prices back up to the present, where they are still climbing. The latest US oil rig count from Baker Hughes, released yesterday, was 1293, up 28 from the previous week and up well over 1,000 from the end of Bush's term. Obama seems rather poor at suppressing drilling activity, contrary to utterances from the right wing bloviators.
Now let's look at a bigger picture for drilling rigs. Yesterday (March 2, 2012) Baker Hughes showed the following in its weekly release. Rigs are the total of active oil and gas rotary rigs.
U.S. had 1989 rigs, up 282 (16.5%) from last year.
Canada had 681, up 56 (9.0%) from last year.
International had 1171, up 10 (0.9%) from last year.
So let's put this into perspective. The U.S. had a 16.5% increase in active rigs last year, despite Obama supposedly suppressing drilling. Canada had only a 9% increase, probably due to Prime Minister Harper being more effective in suppressing drilling; wait -- isn't Harper a big advocate of drilling? I'm so confused. And the international rig count (everything outside North America except Russia and mainland China) increased less than 1%. Why? Well, the rest of the world must be waiting to get their oil from the U.S. because the Republicans promise they will take over the Whitehouse, and America will once again be an oil exporter, and gasoline prices will return to $2. And yes, I'm being sarcastic.
So, what should consumers to do about rising gasoline prices? My suggestion is to drive less and walk or bicycle more.
But that won't be enough for some people. They will want to take action against the "price gougers". Very soon we should all get the "gas out" chain e-mail messages exhorting us to boycott some brand of gas station or another for one day with the goal of driving down prices. It is sad that so many people have so little knowledge of gasoline refining and distribution networks that they think this could work, but such is the case. But I'll let Snopes explain this foolishness.
What else can you do? Well, some people of faith believe that they can "pray away the gay". So it should not come as a surprise when that subsect of society attempts to pray away gasoline prices. For video see here.
And for a society that is accused of worshiping the automobile, it should surprise no-one that SUVs are put on a church altar and prayed over. For video see here.
Now an hour in prayer is not likely to hurt anyone, even if it is about something like gasoline prices. But an hour in prayer combined with an hour learning about energy supply issues will bring a person at least an hour closer to understanding why gasoline prices are rising. And no prayer with two hours studying energy supply issues will bring a person two hours closer to that understanding.
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