Wednesday, April 04, 2012

"Whatever you say Tony"-- Gas Prices edition

In response to a previous post , Anonymous said...

Tony, gasoline prices of $1.80 in 2008-09 was the regression to the mean. Gasoline prices had heated up so much due to demand in developing nations that the prices were being driven up due to demand. When the world was ending in 2008-09 this demand slowed. The current rise in price is being driven by Obama policy. This current $4.29 gasoline is not a return to normal. You seem to be a chartist (I'm a fundamentals investor), if you apply your chartist skills to historic gasoline prices you will see that $4.29 is the aberration. We may have a somewhat strengthening US economy if you can call anemic strengthening. China is in a slowdown. The demand just isn't there to support an argument for current price levels. Some of the pricing can be pegged to Iran but overall the current US prices are on Obama's and Chu's shoulders (and according to Chu we are only about half way to his goal of "European price levels").

While I am loathe to respond to Anonymous commenters, I think I know who this is and the topic is actually interesting, so here is my surmise:

The economics of petroleum supply and demand are far from my area of expertise, but I can find at least three major mistakes with this comment.

1. Global oil demand is higher than ever.
You say, "The demand just isn't there to support an argument for current price levels." Is this true?

Figure 1: Global oil consumption is above what is was in 2008, in fact, it is at all time highs. Period, end of story. This is the only graph (from Bloomberg Financial) you need to see:

In fact, gasoline prices are not as high as would be expected given the higher world oil consumption; they are not as high as the summer of 2008...yet. (I overlayed the gasoline prices taken from  Global oil consumption is almost a direct proxy for global GDP, but gasoline prices are not as clean an indicator since gasoline price is also reliant on refining capacity and the futures market sentiment.

When you say "The demand just isn't there to support an argument for current price levels", what data is this statement based upon?

Furthermore, there are structural factors that favor increasing oil consumption in the decades to come: namely, continued increased demand from emerging economies. Which brings us to point #2.

2. China's GDP is growing

Trust me, China is not in a slowdown. When you say, "China is in a slowdown", what you really mean is that China's GDP projections have been decreased from 8% per year to 7.5% per year by the Chinese government. (Private analysts have been more sanguine and keep growth rates above 8%.)  This is massive growth for the second largest economy in the world and will not change anytime soon.

China GDP (Trillions)             US GDP (Trillions)
2007: $3.5                            $14.0
2008: $4.5                            $14.3
2009: $5.0                            $13.9   
2010: $5.9                            $14.5
2011: $7.3                            $15.1
2012: $8.4                            $15.7  

In fact, not one year has China stopped growing and has more than doubled its GDP since 2007-- doubled!-- which is in line with their oil consumption.  Furthermore, China's GDP is expected to grow at an increasing rate over the coming decade and will surpass the US by 2018....and by extrapolation-- barring new breakthroughs in non-fossil fuel technology-- oil demand will continue to rise. And that doesn’t even count India and Brazil, which are both huge populations with large GDP growth.

When you say, "China is in a slowdown", what data is this statement based upon?

3. US Oil production is higher than 2008.

You say that "The current rise in price is being driven by Obama policy". You don't elaborate what you mean but since Obama a) cannot control foreign GDP growth and b) he is expected to want US GDP growth to increase, barring increased gasoline taxes (which haven't happened) this can only mean that c) somehow Obama's policies have led to decreased oil production.  Is this true?

Figure 2  shows that Annual US oil production peaked in the 1980's and steadily declined until...January 2009 when it began to increase again.  In fact US oil production has increased 15% since Obama took office (see the small blip upward 2009 to 2012). From the US Energy Information Administration:

FIGURE 2: US Annual oil production

Table 1 show Monthly US oil production. Note that US oil production declined steadily under Bush, reaching a 40 year low in Sept. 2008, and has risen to 12 year highs since Obama has taken office..  You brought up "Obama's policy", I didn't. I am the first to say that this increase in production is mostly due to improved technology and oil sands discoveries and presidents have very little to do with oil production, but it’s your argument.  Again from US EIA:

TABLE 1: US Monthly oil production (Thousands of barrels):

So your conclusion that "The current rise in price is being driven by Obama policy" is based on what data exactly?

MY COMMENT 1: The current $3.89 is hardly an aberration, it is right in line with global oil consumption and in fact may be a little low. Expect gasoline prices to rise faster than oil consumption during an economic recovery-- such as we are experiencing now--as refining capacity is maxed out. Also, expect the trajectory of oil consumption to increase parabolically as global demand outstrips supply, barring any new discoveries or new technologies.

One could argue that our recovery is not as robust as we would like, but a more robust global recovery would lead to even higher gasoline prices, and even more squealing on Fox News.  One could also argue that we should be drilling even more oil than we currently are, using new technologies to increase production, etc, but regardless, $3.89 is definitely not  an aberration given the current scenario of supply and demand. Of course, at some point higher fuel costs will begin to have a slowing effect on the US as well as global other words, supply and demand will fundamentally affect oil and gasoline prices as they always do (See MY COMMENT 3 below).

MY COMMENT 2: Energy Secretary Chu's sentiment that gasoline prices are too low and the US should move toward European levels was stated in 2008 before he was Energy Secretary and was his academic stance for a long time. As an academician, Dr. Chu was stating that that the US would be best off if we were not as reliant on foreign oil for economic growth and the only way to change demand is through pricing via taxes.  But, upon joining the Obama administration, in the throes of a crippling recession, Chu said it would be “completely unwise to want to increase the price of gasoline.”

Macroeconomically, given that emerging markets like China, India, Brazil and others will continue to grow their GDP’s at staggering rates, and given that oil prices rise proportionally with world GDP, it’s common sense that our way of life will be negatively affected by the trends that are in place as long as we rely on oil.  If we had diverted our energy use to, say, natural gas (now at generational low prices and all domestically produced) 10 years ago, our economy would be less correlated to the oil hiccups we are experiencing. In essence, Dr. Chu was correct in his sentiment that the US would be well-served changing its energy use to one that is domestically produced from one that is subject to geopolitical stressors and rising foreign demand.

MY COMMENT 3: At some point high energy prices will slow the US and world economies. Rick Santorum recently quoted certain economists who opine that the 2008 credit freeze was triggered by high gasoline prices, and this may not be too far off. Sure, we had a lot of household debt, and sure, housing prices grew too much too fast, but it was only when households faced higher energy costs that they began to fall behind in mortgage payments. Historically, oil shocks often usher in recessions.  And now we may be facing a similar situation as gasoline prices approach all-time highs. Santorum's claim is actually an argument for Dr. Chu's opinion.  If we had followed Dr. Chu’s advice and diverted our economy away from oil then we might have cars run on natural gas today, for the equivalent of $1.50 per gallon. Just sayin.

MY COMMENT 4: How can citizens get information from the media about gasoline prices, presidential policies and GDP? Answer: not Fox News and AM radio.  I watch Fox News occasionally just to see what the lowest common denominator of the national political debate is.

In 2008, Fox News was breathlessly defending Bush against the high gasoline prices: "no President has the power to increase or to lower gas [ie, gasoline] prices."

...and now, of course, high gas prices are completely dependent on presidential policy:

Finally, further Information about externalities and other costs from this quick presentation. One externality they left out was the cost of our military that largely protects the flow of oil around the globe.


Oil prices: A tale of two tails, Calgary Herald, March 12, 2012.

China GDP: How it has changed since 1980, Guardian UK.

Fact Check: Does more US drilling ease gas pump pain? Washington Post, March 20, 2012

Flashback: Fox News on gas prices in 2008, Media Matters, March 5, 2012.

Rick Santorum thinks gas prices caused the recession. Is he right? Washington Post, Feb 28, 2012

Fact Check: Obama wanted higher gas prices, Factcheck*dot*org, March 23, 2012

Everything You Need to Know about Gas Prices, Treehugger Blog, April 2012

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