To antidote pump panic, consult Petronomics 101

by
May 14th, 2006

By Brian Ochsner baochsner@aol.com

Folks who blame Big Oil for higher prices at the pump are just plain economically illiterate. They don’t understand the real domestic and international reasons behind these increases. I’ll put on my free-market professor’s hat and start this session of Petroleum Economics 101. I’ll tell you what’s behind the recent spike in gas prices with solid analysis you won’t find anywhere in the mainstream media.

Supply and demand factors in crude oil and a declining US Dollar are the two main causes. Chris Puplava is accurate in his assessment of this issue, and I’ll hit the highlights in the rest of this post. However, the biggest culprit is Big Government – who takes a larger percentage of ‘windfalls profits’ at the pump than even Big Oil. It’s not just the amount of taxes collected, but the lack of a domestic policy that’s put us behind the energy 8-ball.

An FTC report in July 2005 stated that 85% of the changes in the retail price of gasoline are caused by changes in the price of crude oil. Because we import 60% of our crude oil supplies (and 10% of refined gasoline) from foreign countries, the price of crude is determined in the international markets. Exxon-Mobil and other large firms buy oil from foreign countries, then transport and refine it into gasoline.

I’ll say it again – the price of crude oil is determined by international markets, not the oil companies that buy the oil on these open markets.

That’s contrary to what Dick Durban, Barbara Boxer and Bill O’Reilly are saying. If the “No-Spinmeister” is looking out for me, I think he needs a new prescription from his economic optometrist. Oil companies are an easy target for populist Pied Pipers like O’Reilly, who are economically illiterate. I’ll continue with today’s lesson – onward.

If the increased price in crude oil is the main cause of the increase in gas prices, what are the factors behind the increase in Black Gold?

A big reason is the increased demand for oil from China and India. With their rapid growth and industrialization – and population of around a billion people each – this trend isn’t going away anytime soon. It’s Economics 101: If demand goes up and all other variables stay constant, prices will increase – plain and simple.

Supply is an issue as well. “Peak Oil” is a theory (that now appears to becoming reality) that cheap, plentiful, easily-accessible sources of oil are now drying up. It’s too large a concept to cover here, but I’d highly recommend you read Matthew Simmons’ book Twilight in the Desert .

Simmons is one of the few people to have access to oilfields in Saudi Arabia. He believes that the Saudis (and other oil-producing nations) have overstated the amount of oil reserves they have available. If that’s the case, then the world is closer than we think to be in the era of Peak Oil.

Another reason for the increase in the price of crude oil is monetary inflation – the increasing of money supply by the Federal Reserve. When there’s a larger number of dollars chasing the same number of goods, it’ll take more of those dollars to buy these same commodities. Contrary to conventional wisdom, the Fed doesn’t fight monetary inflation – it creates it.

Although crude oil supplies are fairly high, all the oil in the world doesn’t do any good if it can’t be refined into gasoline. Hurricanes Rita and Katrina exposed these bottlenecks and ‘choke points’ in our energy infrastructure. Refineries in the US are operating at full capacity, and a new American refinery hasn’t been built in the past 30 years.

Bureaucrats and environmentalists with the NIMBY (Not In My BackYard) and BANANA (Build Absolutely Nothing Anywhere Near Anybody) attitudes have put the kibosh on new construction of these much-needed facilities – and drilling for new oil and gas sources. These attitudes don’t apply just to petroleum facilities, but to alternative energy sources as well – and the opposition isn’t just from Greenies or big-government types.

The Master Apprentice www.Trump.com himself – one of the world’s biggest capitalists – recently threatened to Trump construction of a new Scottish golf resort unless development of a wind farm was halted. That’s because the wind turbines would ‘spoil the ocean views from the links’ for golfers and residents.

So, have oil companies done everything right? Of course not. The $400 million retirement package for Exxon-Mobil’s CEO wasn’t the best PR move they ever made. However, they also pay a ton of taxes to federal and state governments. During the ’80s and ’90s, when the oil and gas business went bust (remember the late 80s in Colorado?), oil companies weren’t making much money at all.

Big Oil also carries the risk of nationalization of assets from countries such as Nigeria, Venezuela, and our Muslim ‘friends’ in the Middle East. Bolivia’s new leader, a leftist coca grower named Evo Morales, is nationalizing their natural resources ; Hugo Chavez in Venezuela could be the next to follow suit.

Who is the biggest culprit, making ‘windfall revenues’ from gasoline sales? Why, it’s state and federal governments – those good folks who always try to help us – just like a 5-year-old tries to help Mom make a gourmet breakfast. Oil companies make about 9 cents/gallon profit, while the greedy hand of government takes 40 cents per gallon from your pocket in Colorado, and a whopping 63 cents in California.

That’s the end of today’s lesson in Petroleum Economics 101. There’s no easy or quick fixes to higher gas prices in the US. This trend of higher energy costs are what Americans will see as the “New Normal.” That’s the title of my next post, and I’ll give more details on energy and other financial and economic issues then – stay tuned.

The author can be reached at John@BackBoneAmerica.net

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