On The Price of Oil and Gasoline: Why Is It So Much and How Can It Be Reduced?

President George W. Bush was a terrible president – arguably the worst ever.  That said, he did one thing that I really liked: he greatly increased the American production of natural gas – which is why its price has fallen by one third to one half of late.  Why then have the price of oil and gasoline stayed so ridiculously high when the cost of natural gas has fallen?
Usually, pricing is based on fundamentals – that is: supply and demand (see my upcoming blog on that).  I am not an oil-industry-insider, but I am a student of Economics (my second degree is in Economics) and I do talk regularly with several investment professionals who know a thing or two about this.

In the case of natural gas, supply means drilling, storage and distribution pipelines.    Demand for gas depends primarily on energy generation, winter heating for buildings, chemical processing (uses gas as a feedstock).

In the case of oil, supply depends also on drilling, storage and distribution.  It also depends on refining too – which is presently the most constrained part of the petroleum supply chain.  Demand for oil depends on absolutely everything in the economy.  There is no sector that is not in some way touched by oil.  Oil is for the 20th and 21st centuries what coal was for the 18th, and 19th – that is: oil is everything.  We have also seen that the price of oil (much more than natural gas) is responsive to very small fluctuations in supply and sometimes demand (notice that prices bounces around with every hurricane in the gulf of Mexico, every bombing in Iraq, every refinery fire and the economic indicators – which hint at future demand).

Notice that physical supply of oil has kept pace with physical demand for oil at all times during the recent past and present.  No one has ever waited in line for rationed gasoline in this decade like we did in the 1970s.  To my mind, supply and demand fundamentals dictate a (recession) price of $25 per barrel of light sweet crude oil and an average US price of $1.00/gallon for 87 octane gasoline and a recovery (long term) price of $30 to $35 per barrel of oil and about $1.60 per gallon of gasoline.  If we invested in a few more strategically placed refineries and tank farms, we should be able to collapse the long term price of gasoline down to about $1.30 per gallon for gasoline.

Presently oil demand also depends on speculation.  Depending on who you talk to, speculation may represent a larger demand than physical demand and it most certainly represents a larger portion of the price.  Various investors began crowding into the market beginning in 2007, seeking a safe place to park their money while the economy imploded.  This just further drove up the price, and further contributed to economic ruin.

The Democrats, who are usually considered the more progressive party blocked the Republicans’ reforms that were intended to reduce price of oil.  They were actually good reforms – which may be part of why the Republicans are presently blocking so many of the Democrats’ initiatives.

Wouldn’t it be a good idea to package together several effective oil reforms including both those favored by the left and those favored by the right?

REFORM 1 (for the right):  All areas of the country should be made available for oil exploration and drilling.  Environmental regulations should be relaxed if a case can be made that not too much harm will result and it is needed to make the project practical.  Polar bears are cute and loveable, and I realize some may die because of increased drilling, but I will pick peoples’ needs any day over animals’ needs.
·    Benefit 1 – Energy, which petroleum can be used to create, is a key input for our economy, particularly transportation, manufacturing and farming.  Petroleum derived products such as pharmaceutical drugs, plastics, (synthetic) rubber, lubricants, fertilizers etc., are essential to our modern way of life.  All other things equal, more petroleum supply means that we can produce more goods and services.
·    Benefit 2 – it would increase domestic supply by a significant amount (depending on how much is drilled how soon)

·    Benefit 3 – it would improve our military preparedness.  The military consumes astronomical amounts of fuel and lubricants.
·    Benefit 4 – it would increase supply in the entire global market by some small amount – a psychological boost.  Possibly, it might be enough to restrain future price growth in some small way.

REFORM 2 (for the left):  All commodities traders should be required to have physical capacity to receive, store and either process or consume the amount of the commodity they are trading.
·    Benefit 1 – it would get most of the speculators out of the market, thereby bringing the price down to realistic levels
·    Benefit 2 – those speculators who remain in the market would have to build tank farms, refineries etc.  More refinery and storage capacity can only help to improve price stability.   I suspect, but have no numbers to prove this: having an extra bit of capacity in the supply chain can reduce price volatility, enough to pay for the added costs of installing new capacity.
·    Benefit 3 current capacity (especially in refining) is barely adequate for present consumption.  It would greatly help our military preparedness to have increased capacity in the petroleum industry.
·    Now is the time to make this reform: prices and profits have been ridiculously high for several years.

REFORM 3 (for everyone):  No new oil-fired power plants or oil heating furnaces should be allowed in this country, excepting certain extremely rural places where there is presently no other available source of energy.  Furthermore, A small development grant should be awarded to study the feasibility of running freight trains on either hydrogen fuel cells or compressed natural gas instead of diesel.
·    Benefit 1 – it will reduce winter heating cost over the long term.  Natural gas is much more cost effective per BTU of heat for building heating applications
·    Benefit 2 – it will reduce electricity cost over the long term.  Almost every other source of fuel is more cost effective per kilowatt-hour of electricity production than oil; for example, coal, nuclear, wind, hydro, geothermal are all more cost effective than oil per kilowatt-hour.
·    Benefit 3 – Hydrogen fuel cells (that are recharged by electricity from coal or nuclear) could easily become much more efficient than diesel per ton-mile carried in terms of energy consumed and carbon dioxide released.  This makes it cheaper and greener at the same time.
·    Benefit 4 – Hydrogen fuel cell s require a fair amount of infrastructure to support cars that go everywhere – but nor for trains that are limited in where they can go.  By starting with trains, we might be able to very cheaply give hydrogen fuel cells for cars a chance to get off the ground.
·    Benefit 5 – To the extent that this causes a reduction in carbon dioxide emission, this will also make Greens happier about swallowing reform 1.
·    Benefit 6 – To the extent it reduces future demand for oil, it will help to restrain future price growth in the markets.

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2 Comments on “On The Price of Oil and Gasoline: Why Is It So Much and How Can It Be Reduced?”

  1. Roger Sowell Says:

    Sir, you are far off in your conclusion that more refineries or more storage will reduce prices of petroleum products.

    see http://sowellslawblog.blogspot.com/2009/11/more-refineries-closing-in-usa.html

    • Sir, this is a more nuanced problem than you are allowing. Increased capacity in refining and storage would help reduce price level and price fluctuation in the long run.

      Before that, I will first concede that, at present, there is over-capacity in refining as your article shows. I did not realize the extent of the short-run problems your industry faces. Thank you for pointing that out to me and let me express my sympathy for your industry’s short-run capacity issues. Second let me say that I was impressed by your website and your credentials.

      Now, consider that the present over-capacity is occurring at the bottom of the business cycle. In the long term, demand is higher and prices are increased to the extent that suppliers sometimes can’t keep up with demand. Recall the New York Times said in 2007: “Refineries are a choke point. Because they have not invested sufficiently in refineries to increase gasoline supplies, oil companies have been unable to meet the growing demand in recent years.” (http://www.nytimes.com/2007/05/24/business/worldbusiness/24iht-prices.1.5851637.html)

      Furthermore, during past times of normal to high demand, we were vulnerable to seasonal and various unexpected variations in prices of petroleum products. Recall the temporary spike in prices sin 2005 when hurricane RITA looked like it was going to damage the greater-Houston-area oil refineries several years ago. (http://www.redorbit.com/news/business/249049/analysts_expect_gas_oil_prices_to_rise_from_hurricane_rita/index.html)

      Increased capacity in refining and storage would help reduce price level and price fluctuation in the long run.

      Thank you for your comment.

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