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Oil Prices: Free Market Economics at Work?
I had an interesting discussion with my wife this weekend about the gas / oil prices. Basically she was curious about why the increase was happening, etc.
Disclaimer: Before I go any further, I should note that I am not an expert in these areas, and these are merely my observations. I would be more than happy to learn through people disagreeing.
First, I had to clear up some misconceptions. Things like, ‘the high price of gas isn’t really because of taxes’ (several governments have tried reducing the taxes, only to have gas companies keep prices the same).
Then we got into OPEC. An interesting discussion, mainly because over the weekend several things happened (this article is a good starting point if you haven’t looked into this recently):
1. OPEC is losing control of oil prices
2. OPEC is basically at peak production
3. OPEC has lost control of member countries’ total output
Each of these is a monumental event in and of itself, and well worth tackling, before I get to the Free Market stuff.
Control of oil prices
For the longest time, OPEC has regulated prices based on pure market supply and demand. When they wanted to raise prices, they cut production. When they needed to drop prices they raised it.
However, a new force of demand has come into play in the last year, a huge new factor: investment banks. Investment banks, particularly in the states, have realised that (by and large) oil is an upwardly mobile commodity. As such, they have started purchasing huge amounts of futures while also shorting the commodity, which (apparently, maybe an expert can explain this better) has the net effect of putting upward pressure on the prices… To the point that OPEC can no longer actually control the price.
The reason? Beyond the political issues, instability, etc (nothing new): production.
Production
On the record, OPEC has stated that they have roughly 15 million barrels per day of spare capacity. The problem? All member nations, with the exception of Saudi Arabia, have been producing over their caps (actually, producing at peak) for the last 2 months. Saudi Arabia came to this weekend’s summit with one goal: to make sure it could also raise it’s production to peak.
Anyone who doubted that an oil shortage could ever hit us will soon be waking up. The group of countries responsible for producing well more than 2/3 of the crude oil is now at peak production. They could probably tap another 5 million barrels in an emergency.
Scary times.
Control of countries
This is self evident. As soon as countries start exceeding their cap, they are opening the door for direct negotiation of prices, instead of through OPEC, something which has obviously already begun.
Free Market
While all of this was background info to me that I was vaguely aware of, while talking to my wife I suddenly realised that the investment banks could be ushering in several fantastic things:
1. By driving oil prices higher, the differential between the cost of oil and of alternative fuels becomes drastically smaller
2. As oil prices raise, consumer ‘itch’ for alternate solutions skyrockets
3. As consumer interest raises, the motivating factors to produce alternate solutions grows exponentially
All of this is interesting because it gives the car makers and politicians good reason to stop fearing change. But, it also has a huge other impact: venture capitalists.
At last estimate, VC’s had roughly 50B$ just sitting in the banks. Sitting there, waiting for something to invest in. Also, at last estimate, it would only cost 100B$ (yes, yes, the same amount Bush wants to put into the space program) to put a basic hydrogen infrastructure in place.
The reason this excited me is that while I wish the government did get involved in the switch to alternative fuel, I am also fully aware that if it happened, it would be ‘unnatural’: the government’s ability to time economic changes to the benefit of everyone is sketchy at best.
A free market, though, driven by supply (both of cash and willpower) and demand (for reduction of our reliance on oil, cheaper vehicles, more convenient fillups) could easily collide in the next 5-10 years to create an environment where there is investor willingness (VC’s); innovation (new companies); government support (for votes) and consumer demand (for cheaper prices at the pumps).
All of this would create a much more natural environment for this change, one where the free market principals which apper that they could be pushing us away from a fossil-fuel-based economy end up generating enough momentum to push us into a hydrogen (or other) fuel economy with the least amount of pain possible (the basics of a free market economy).
Am I convinced? Far from it, but the idea that our self-regulating market might just be smart enough to push for what’s best for us was exciting: theory into reality, so to speak.
Aside: While many people would hope that a hydrogen economy in which production of our fuel source would mean insanely low prices at the pump (10-205c/gallon) or even membership-based fillups, I don’t see that happening. The government will still want a large cut, and profits will still be expected, especially at first.
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| Print article | This entry was posted by Jeremy Wright on May 25, 2004 at 12:11 pm, and is filed under Business. Follow any responses to this post through RSS 2.0. Both comments and pings are currently closed. |
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about 7 years ago
There is a missing component in most discussions regarding oil prices per barrel and gasoline prices per gallon: Refineries. Discussion has been bubbling up for the past decade about the production capacity of oil refineries (example: “Refineries Turning Oil Into Gold” at http://www.fool.com/news/2001/vlo010604.htm). If we don’t have an adequate refinery capacity, then an abundance of cheap oil won’t have much effect on the price of gasoline.
about 7 years ago
I thought Bush used to have a very senior role in an Oil Company and still maintains links. I think the last thing he would do is start looking at alternative fuels.
I’m probably speaking out of my backside, so there is some pretty good info here: http://www.rotten.com/library/bio/presidents/george-w-bush/
“People like to assume that George got rich from oil speculation. It’s a simpler and more inspiring explanation than the truth. He did launch an oil business, Arbusto Energy, in 1978. But it was a financial disaster from the very beginning and never turned a profit. Fortuitously, it got swallowed up in a 1982 merger with another energy company named Spectrum 7. The merger was engineered by a couple of Bush family friends. For some reason they opted to rescue the son of the Vice President of the United States from his own financial catastrophe and make him the CEO of the merged entity.
Four years later, Spectrum 7 was itself floundering underneath $3 million in debt. Which is when Harken Energy, yet another company run by a family friend, came in and bailed out Bush’s enterprise a second time. George was given a fat wad of stock options and a $120,000 annual salary, but no actual work to do.
Technically, Bush’s official capacity was as a member of the company’s audit committee, charged with overseeing the major deals and transactions to ensure that everything was on the up-and-up. But as the son of the U.S. President, Bush’s true function was to act as a lure for investment money. His task was schmoozing business contacts and outside investors, interested in converting cash into a friendly acquaintanceship with the President’s offspring. And he was good at it. Hi, my name is George Jr. My Daddy lives in the White House. Let me show you around.
This investment capital really helped prop up Harken as it was secretly bleeding money out of every orifice. As a matter of fact, Harken was hiding massive debts through shell companies and byzantine practices masterminded by the now-infamous accounting firm of Arthur Anderson. One such deal was the putative “sale” of Aloha Petroleum to Intercontinental Mining and Resources Ltd in 1989. In actuality, IMR Ltd was just another company owned by three members of Harken’s board. And the terms of the sale were extremely sketchy: although IMR agreed to pay an exorbitant $12 million for Aloha Petroleum, they wouldn’t be required to make any payments for three years. Nevertheless, Harken immediately booked an $8 million profit.
The technical term for that is fraud. But you can’t really blame George for that, can you? It wasn’t like he was serving on the corporation’s audit committee or anything… oh wait, he was. In fact, Bush signed off on the Aloha Petroleum deal. This deception helped maintain the illusion that Harken was — what’s the word? — solvent for several months after it had actually run out of money.
A few weeks before the house of cards finally came tumbling down, Bush engaged in a little insider trading and sold off $848,560 in Harken stock. Then he waited eight months to notify the SEC of his sale.”
about 7 years ago
Regarding Bush’s role in oil companies, it seems that a lot of people want to make him out to be a failure in every aspect of his life because they don’t like his politics. If his role at the company was to get people to invest, and he successfully got people to invest, then he did a good job! Good rainmakers are very hard to find. Yes, he took advantage of his Washington connections, but doesn’t everyone who has any connections try to take advantage of them?
Now, regarding alternatives to gasoline powered cars, in Europe they allegedly pay a lot more for gas (I’ve heard $5, $7 a gallon, not sure right now) but they still drive around in regular gasoline or diesel powered cars just like here. The only difference is that the typical car in Europe is a lot smaller than the typical car in America (where huge SUVs are quite popular). People just don’t appreciate what a great and inexpensive technology the gasoline powered combustion engine is.
about 7 years ago
Hydrogen should not be thought of as a ‘fuel’ but rather as a temporary storage medium. It does not occur in useable form in nature, so you need some other source of energy to make liberate it from water or from natural gas. Those who advocate the ‘hydrogen economy’ should specify where they are planning to get the energy to produce the hydrogen. Coal? Nuclear power? Wind?….Just building “infrastructure” (gas stations, pipelines, etc) doesn’t solve this problem.
about 7 years ago
The larger the hydrogen economy becomes, the less power is needed to produce hydrogen. Right now it’s rather high (1Watt/Litre). But, exacting hydrogen from water is a very, very scaleable process. The same amount of power (roughly) is required to convert 1 Litre as to convert a million litres.
If a hydrogen economy does happy, we’ll see huge reservoirs of water being used to create huge amounts of hydrogen, or we’ll see thousands of smaller tanks being linked so that the power can transfer through them.
When you’re creating hundreds of millions of “litres” (how is hydrogen measured?) at once, using renewable sources of energy like solar and wind all of a sudden becomes quite feasible.
about 7 years ago
As you refer to peak production, I can only assume you mean producing at current capacity. Peak production, in Hubbert’s Peak terminology, refers to the maximum level of production that will be achieved, and it is all downhill from there. The US reached peak production in the early 70′s. I don’t believe that there is any evidence that most OPEC nations are currently at peak production. If they were to invest in new capactiy, they could produce more.
I too share your enthusiasm for alternative fuels, but I also would like to see us drill ANWR and open up the eastern Gulf of Mexico. The more we can do to mitigate the massive wealth transfer of Americans to religious fanatics and dictators, the better.
about 7 years ago
>>
The larger the hydrogen economy becomes, the less power is needed to produce hydrogen. Right now it’s rather high (1Watt/Litre). But, exacting hydrogen from water is a very, very scaleable process. The same amount of power (roughly) is required to convert 1 Litre as to convert a million litres.
about 7 years ago
Mark,
There are several ways to get hydrogen out of water, one of which is essentially (really, really simplified) high-powered electric current through the water.
Because water is nearly totally conducive, roughly the same amount is required for 1 litre as any amount above that.
Strictly speaking that isn’t true (more harvesting of the hydrogen does require more power), however the ratio isn’t 1:1 (power required per litre). It’s much more like 1:20 with current technology.
Some of the hydrogen guys I know say this could easily be 1:1000 with proper investment and proper scaling.
I’m not sure if this helps, though I’d be quite happy to put you in touch with some industry insiders and resources you could poke at specifically :)
about 7 years ago
We read a commenter above who says that Bush has no incentive to pursue alternative engery sources because of his tie to an oil company, or to the industry.
This is pure bunk. It’s bullshit of the hightest order.
First, there are no major oil companies that see themselves as “oil companies.” They are ENERGY companies. They make their money off of producing energy. And when it makes economic sense to produce energy from sources other than oil, they will do so. It’s either that, or go out of business, because once alternatives make economic sense (which so far, is not the case), then the fuel producers either get on the bandwagon or go out of business.
The only mitigating circumstance here to this assertion is that sustainers often to not recognize disruptive opportunities soon enough (see Clayton Christensen).
about 7 years ago
Hydrogen gas requires fossil fuels to produce. Consider that most of the fossil fuel at a refinery is spent in the refinement process. Next, you have the air-sep industry who produces the hydrogen. Consider that the air-sep industry is probably the second largest consumer of energy, after the petroleum refinement industry, and you can see the costs adding up. Hydrogen is also difficult to contain because the atom is so small, and leaks plus heat can result in explosions. I truly don’t see this as a viable source of power but I do see it as a diversion to mislead people to believe we are missing the boat by not utilizing hydrogen power. If someone knows more about this, please convince me.
about 7 years ago
I don’t think this is going to have much of an effect on the move toward alternative fuels.
Despite what many people like to think, the push toward alternative fuels has nothing to do with any oil company/government conspiracy and everything to do with basic economics. At the current state of technology, oil is the cheapest source of portable fuel we have. The only source of fuel that’s more economical is coal, but that’s not practical for vehicles. And the fact of the matter is, the difference in costs is so large that even now that gas prices have almost doubled in the last few years, it still holds true.
Consider the following:
1) Adjusted for inflation, gasoline prices are still less than half what they were during the “oil crisis” of the 1970′s.
2) Given the American propensity toward larger vehicles, even though our gas prices have doubled in the last two years we could easily make up the difference by simply switching to more effecient vehicles using technology that already exists – “upgrading” to more fuel effecient small cars, dumping the SUVs, and – if all else fails – switching to hybrids, which are already road tested.
3) Why? Yes, gasoline prices are high, but so what? Americans drive a *lot* more than they need to – and they haven’t shown any signs of slowing down, despite high gas prices. In fact, that’s largely why the prices are so high. Americans keep driving, and they’re willing to pay for it. As demand rises, so will the price of gasoline, until they reach equilibrum.
4) Why? Have you ever sat down and calculated how much you spend on gas per year? Have you compared it to the other costs you pay in order to drive? I think you might be surprised if you do. Before I bought my last car, I was seriously looking at the hybrids. I concluded pretty quickly that they simply weren’t worth the money. A Toyota Prius costs roughly $3000-$4000 more than a comparable non-hybrid car – a car which would, by virtue of its class, already be getting 30-40 mpg. So “upgrading” to a Prius costs $3k extra, and gives you roughly 30mpg extra. I’ll be generous and say you get a 100% increase in mileage (30mpg pumped to 60mpg – real mpg, not rated mpg).
Now, say gas costs $2 per gallon (roughly current prices). Your first hundred thousand miles of your alternate car would use three thousand, three hundred thirty three and one third (I couldn’t put it as a number because it was “questionable content” – sheesh) gallons of gasoline, which at $2 per gallon costs $6666.66. Because the car cost $3000 extra, you won’t even break even for 50,000 miles. If, like most Americans, you average about 12,000 miles per year, it’ll take you four years just to break even, then another four years just to make $3k worth of extra money. $3k over 8 years is $31 per month – it’s real money, but you won’t see any of it for four years. Instead, you’ll be paying *more* for those four years (the life of a typical auto loan) as you pay off the premium of your car.
My point isn’t to argue against hybrids – in the long run, they are actually more economical. But even after 100,000 miles, you only save $3k. Compare that to the $20k price tag of the car, the $7k you’re *still* paying for gasoline, even with the high fuel effeciency, and roughly $5k in service and maintenance fees, and it’s just not that big a component in the price of your car.
Now figure in the popularity of big SUV’s in the US ($30,000 and up vehicles), and it’s easy to see that even with low gas mileage and the current over-inflated price of gas, it’s just not that huge a component of the total cost of ownership of your vehicle. Prices would have to get a *lot* higher than they are now, and gas a lot scarcer, before it forced any kind of switch to another fuel.
My guess would be that even $10 a gallon wouldn’t force it a whole lot quicker. Even if the demand comes, it’s going to take time to flesh out the technology. And though I believe hydrogen to be the fuel of the future, it’s just not ready for prime time yet.
–Russell Newquist