Rising Gas Prices: Welcome to the global economy

In 2004, then California Attorney General, Bill Lockyer, updated his 2000 report on Gasoline Prices in California.  Looking back, this is an interesting read as we watch gas prices rise beyond $4.00 on their way to, as some are predicting, to as high as $6.00, if not even higher.

Evil Oil Companies Reap Big Profits Cause Gas Prices to Spike!

What is fascinating about both the current concern over the rise in gas prices and the report published by AG Lockyer is the consistent amount of spin on what it was that was causing the rise in prices.  As we move into the next few weeks and months, once again, we will hear from the media, and many talking heads, how this is all the “evil” oil companies’ fault.  How they are making record profits, and they are simply preying upon the people of California, or on the national scale the U.S. citizens, to enrich their shareholders and continue to pay huge salaries and bonuses to the 1%’ers and leaving the 99%’ers in a continually worsening position. But there is a big problem with this spin!  For the most part, it is just not true.

Look, I have no vested interest in the oil companies, and I am by no means a fan of some of what they sometimes do.  Sure, oil companies make a huge amount of profits when you look at the overall dollars, but, like other such vilified industries and their executives including, big Pharma and insurance companies, among others, the percentage of profit is ridiculously small when compared to other businesses and most small businesses.  More telling, however, is that the real profit built into the gas and oil supply chain has reduced significantly since Lockyer published his updated report in 2004.  The enclosed chart shows the break out of costs for a gallon of gasoline as reported by the California Energy Commission in 2004 and again today in 2012.  What is startling is that the “evil” oil companies and refineries have reduced the cost and profit part of the price by over 27%. In comparison, the state of California has increased its percentage per gallon by over 42%, and the federal government has also increased its take per gallon by 20%.

Another great misconception—perhaps misrepresentation?—is that the cost per gallon is driven solely by the per barrel price of crude oil.  Well, again, if you look at the table I prepared, you see that if that logic were, in fact, correct, the price per gallon would now be $6.02 per gallon already instead of the $4.04 it is today.  So, there is some disconnect in the price per barrel equivalence to the price at the pump.  Clearly, there is not a direct corollary.  While it likely does have some impact, I suspect there are many other things at work that drive the price at the pump. So, one may want to question if the conventional headline shown at the beginning of this section is true?

What else could be driving up gas prices in California?

One other interesting segment of the Lockyer report is the change in 2004 from MTBE to ethanol.  For many who don’t know, and for those that do not remember, MTBE was the additive to California gasoline to reduce pollution as demanded by the environmental movement.  In 1990, with a large amount of money and huge political activism, environmentalists lobbied the U.S. to amend the Clean Air Act requiring 2% oxygenating additives (typically MTBE) to lower pollution.  The cost of refining gas for use in California went up, and so did the taxes on gas to help pay for the increased bureaucracy required to monitor compliance.

Now, like most things driven by ideology, many years later, the same environmental factions came forward to demand the removal of MTBE from our California gas as it was polluting the environment (it had been found in high concentrations in the water table of Lake Tahoe and the water table).  So once again, Californians had to foot an increase in the cost of gas as a result of this change and an increase in the cost of the additive (ethanol) as well as an increase in the bureaucracy to manage compliance—oh and let’s not forget the increase in fees and taxes. So far, I have yet to see an acceptance of responsibility for the initial inclusion of MTBE in the first place, no offer to pay for the removal, and no apology for the mistake from those that promoted the MTBE solution in the first place! (If you would like to read an interesting article on this, read MTBE: A PRECAUTIONARY TALE by Thomas O. McGarity, June 2004 in the Harvard Environmental Law Review)

The Law of Supply and Demand

Recently, some news outlets are questioning why, since the general demand for gas and oil in the U.S. is down significantly and we have had a surplus in supply, prices are still rising—not falling as predicted by the law of supply and demand.  Welcome to the One World Economy.  There are those in the progressive movement. Evidently, our President included, that have long desired the U.S. to become a member of the One World vision—a One World Economy.  For the past 20 years, much of Europe has been experimenting with this grand vision of utopian fairness.  Looking at the status of Europe today, particularly Greece, France, Italy, and Spain, one would really want to ask how this is working out for the citizens of those countries!

The problem with the One World Economy is now supply and demand for our U.S. refined products, regardless of their in-ground point of origin, is based on demand anywhere in the world.  One can take a narrow view and determine that oil refined in the U.S. should stay in the U.S. Still, economically, that doesn’t work because when “evil” oil companies ship this product to other markets, that will pay a higher price; it is actually a good thing for the economy because the U.S. adds revenue to its export sales, reducing the amount of money we need to print to pay for our international purchasing deficit.  We must remember that the U.S. is a net importer of products; therefore, more of our dollars flow out of the U.S. than we get back in sales of our goods and services outside the country.

As an example, suppose you live in a house with your wife and one child.  Your mortgage is $1,000 per month; your other expenses are $1,000 per month, you and your wife both work, and you both get paid $1,500 per month.  You are selling your services above what you are spending, and each month you gain a real asset value of $1,000.  Let’s assume one of you loses your job.  Now, each month you are buying $500.00 more in goods and services than you are taking in.  All things being equal, you can do this for twice the amount of time of when you were both working. When you get to the point that you have spent all the money you accumulated (saved), you look in your checkbook and see you still have checks.  So you keep writing them.  It won’t be long before someone comes and knocks on your door.  For the last fifty years, we have ignored this very problem of just writing checks because they were in the book and now have a $12 trillion accumulated trade deficit and have over $16 trillion in currency in circulation.  Not only is this a big problem for our general economy, but it is also a big problem when it comes to commodities that have real tangible value, like gasoline and oil.

Since we eliminated the international gold standard in 1972, countries whose economy is based on net exports of predominantly tangible goods and services (like manufacturing and raw materials production) have currencies, like China’s Yuan, based on increasingly real tangible values.  Being a net importer with little manufacturing and raw production, the U.S. has an economy whose currency is more and more based on intangible, perceived value like debt against real estate or financial securities.  While the U.S. dollar is still the benchmark currency, the perception of many in the world is changing.  Oil is perhaps now the single most valued commodity—not in price per se but in need.  Its price, like gold before it, is set by world demand. Some argue that “petrol dollars” should become the new world benchmark.  In other words, it would be the new gold standard.  The day that the dollar is replaced, the U.S. currency will get crushed! If you think gas is expensive now…

So companies selling products today have an interesting problem when it comes to U.S. customers.  They can take their production and sell it to us and get paid in a currency with a total amount of money in circulation of $16 trillion. It is arguably a real tangible value of only $5 to $6 trillion. Remember they will be selling this valuable commodity to a country that each year is buying much more than it is selling, so the tangible value of the assets backing its dollar is continuing to slide down or, they can sell them to China whose currency is now internationally recognized, is relatively stable, and is backed by a constantly increasing national asset base due to huge net exports and low manufacturing costs.  Barring a simply patriotic reason, most will sell to the increasing asset value country.

Drill Baby Drill

We can increase domestic production, we can drill more, and we will find that we will reduce local prices somewhat.  While the President says that drilling will not solve the problem, he is not telling the whole truth.  We can’t mildly increase our production; if we do, then he is correct.  We have to significantly increase production to have the effect we seek. The break-point for lowing domestic costs is when we get enough production to reduce the dependency on foreign oil to such a level that the vagaries of their price gaming become meaningless.  There are enough oil reserves in the U.S., with existing technologies to get to it, to replace most, if not all, reliance on foreign sources.  What is necessary to get there is time and the will of the people.  Unfortunately, we are coming to the point when we must face the reality that while protecting the environment is a noble goal, it cannot be the only preeminent factor in all our decisions on the energy issue.

Finding alternative sources for energy is definitely a necessary step and is a proper goal.  But, the solutions found in the alternate sources can neither cost more than the available domestic oil, gas, and coal sources, nor can they require us to collect taxes from some, or all, to subsidize the price to pay for us to use it.  Following the subsidized route as we are increasingly doing in this and other industries is the height of lunacy.  The money we need can no longer come out of thin air as it has for the past forty years.  Taking money from ‘us’ to pay for purchases by ‘us’ from ‘us’ is not only a zero-sum game. It is simply increasing our costs as a nation and making us further uncompetitive with other nations who, in turn, are happy to produce the goods that we can actually afford to buy.  In the end, we will be at the same point we are right now with gas and oil today.  We can produce it, but we can’t afford to buy it.  So then we have to sell it to countries that can afford it like China.

Do you think we will ever learn?