Monday, August 29, 2005

Econ 101

A good friend of mine forwarded an email to me from a long, and I mean long, chain of people suggesting that Americans "show the oil companies" and don't buy gas on September 1st. What followed was a specious analysis of how much it would hurt the oil companies.


Why? Because the next day people would have to make a purchase to make up for the one they didn't make the day before. There are only three ways to impact the price of gas and one of them, governmental control, would be a disaster and a non-starter. Therefore it becomes a question of supply and demand.

Demand has grown tremendously in the past decade and it isn't all due to the fact that everyone bought an S.U.V., although that has something to do with it. The increasing industrialization of China, and the incipient economic growth in India, the two most populated countries on earth, has a lot to do with it as well. The only real question here, and we are beginning to have the answer adumbrated, (sorry but I love that word) is at what price point is consumer behavior changed? Ask an R.V dealer and he will tell you. Find out how cheap used S.U.V.s are, especially lease returns. If you can find an airline executive that hasn't jumped out a window, ask one. The tipping point here seems to be about $3 a gallon.

Supply is another matter. Of course Big Oil and O.P.E.C. are making a lot of money right now, but they don't like prices this high either. Why? Because not only does it begin to change consumer behavior, but it also makes other forms of supply economically feasible. Consider this article from Macleans. Even if the speculations are 25% accurate, this is big news. Why do you suppose we haven't tapped this before? Because when the average price of oil over a period of three years is $40 a barrel, and it costs that much to process oil sand, no one makes money and there is no reason to do it. Yes, I know oil is $68 a barrel now, but how long will it stay that high? A nightmare scenario is for a company to invest billions of dollars into processing oil sand and find that consumption has declined (the tipping point mentioned above) and that supply has therefore increased. Would any of you buy a dime for 25 cents?

The last issue, and one inexorably intertwined, is the capacity to refine the oil into gas. America hasn't built a refinery for two decades; part of the reason is market driven, if it costs more money to build a refinery than it can make, it doesn't get built. The other issue has been environmental concerns and the endless litigation costs involved in even preparing an environmental impact report. But again, as oil prices rise these costs become less prohibitive.

Oil exploration and refinement are amazingly complex businesses with a tremendously high barrier to entry. There will be no quick fixes, and $2 a gallon gas, at a minimum, will be with us for the foreseeable future. However, it is these same prices, as frustrating as they may be, that will ultimately force us to solve this problem through conservation, exploration, and the development of new technologies like hybrid cars.

Adam Smith was right.


Anonymous jedwards said...

there "are" only three ways....

come on gt, you know better!

4:27 PM  
Blogger GT said...

Yes, Janet, you are right. You rightfully expect more from someone who recommened Eats, Shoots, and Leaves, to you.

2:12 PM  

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