09 August, 2005

Economics 101

Saurav points out this soothing Economist article which suggests that we need not necessarily fear for the future because of high oil prices. They say:
Nonetheless, relief may be on the horizon, though perhaps not as near as consumers would like. America’s Department of Energy predicts that growth in Chinese oil demand—one of the main factors driving current price levels—will moderate, increasing by 600,000 bpd in 2005 and 2006, down from 1m bpd in 2004. And there remains the possibility of a delayed reaction to current price levels, as consumers, particularly profligate Americans, turn to less thirsty cars and appliances.
Nuts to that. Check out the EIA projections, including the figure to the right. Petroleum consumption essentially means "driving" - 60% of crude goes into transportation of one sort or another (planes, trucks, automobiles). We've showed a pretty consistent trend since 1980; in order to reverse the natural tendency, either (a) technological innovation or (b) economic contraction has to take place. There WAS a huge round of conservation in the late 70s that produced a drop in consumption. But it followed on the heels of a terrible recession. And we happened to have people in power who were willing to make the necessary sacrifices (like impose more exacting standards on industry). It was not a purely market-imposed correction.

Also note that the Economist suggests moderation as a result of decrease in Chinese demand growth, not demand. This is just plain stupid. If demand continues growing and supply does not (which it cannot), then, obviously, price will increase. Even I know this.


In the long run (like 20 years) absolutely. In the short run. . well, the problem is, most people actually acting in the market only care about the short run, and in the short run it is possible to increase Supply.  

Posted by Saheli Datta

In this case, I don't think it IS possible to increase supply in any meaningful way. The traditional safety valve (OPEC) is busted. (See Hedgehog's comment in the NOPEC post below). They have no spare capacity. The alternatives include new sites for drilling - but these take a long time to develop, and in all probability by the time they get going, global production will have slipped even further; heavy crude, which requires extra refining capacity that doesn't exist yet, and is more expensive in mere dollar terms to boot; and weaning ourselves off oil. We seem to have scuttled that last option today with this energy bill. It's got to be medical experiments for the lot of us. Err, I mean, economic contraction and high oil prices. 

Posted by saurabh

One skeptic note: I think that because we are so monstrously overconsuming oil, it might be possible to skim a whole bunch of consumption off quickly. In California, when the electricity crisis hit, in addition to some of the temporary measures they took, they found ways to permanently reduce electricity usage by some whopping figure (10%? I need to find my data) within weeks. Yes, electricity is different than oil, because so much of oil goes to transportation. Yes, the federal government is less responsive than the state government. But there's still a lot of fat to be shed before it hurts. 

Posted by Dan

More on the lack of supply: Everyone complains that no new refineries have been built in the US in decades. It's a sort of fair complaint from a free-market point of view, as refining is definitely one of the bottlenecks to greater US supply and thus lower prices. Refining margins -- the amount of your gas card payment that goes to refiners -- are high.

But there's probably a good free-market reason why we don't have new refineries, too. For one thing, they are net economic losers for their communities. They bring in money from the broader economy (though the marginal profit on each new refinery is likely to be lower than the last, as new refineries reduce the refining margin) but they destroy real estate value. Since only a few hundred people are going to work at a refinery, but thousands to millions of people have a financial stake in stopping it, they stop it.

In addition, companies have no interest in building new refineries during a time of predicted declines in oil availability. The only new refineries they are likely to build any time soon are in the northern US and southern Canada, to refine tar and oil sands. These could be very profitable at current oil prices. But at a billion bucks a pop, companies thinking of building new refineries need some assurance that oil prices aren't on a bubble. Then they need a few years to site, build, and test the refinery.

So in the short term, supply is untouchable. In the medium-term (a few years to a decade) it could be increased a bit through oil sands. In the long term, it rather depends on 1) whether the oil sands live up to their promise, in which case supply could increase quite a bit, and 2) whether humanity survives the inevitable epidemics that will arise as the increasingly populous terrestrial regions now known as Florida, Bangladesh, and coastal China (among others) are inundated by increasingly intense coastal weather and gradually rising seas even as their nutrition is devastated by the collapse of fisheries and desertification of farmland.

Oh I forgot -- the Floridians, Bangladeshis, and Chinese will be able to drive  away from the coasts. And take their oil refineries with them. 

Posted by hedgehog

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