Not So Dismal

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Posts Tagged ‘Demand

Why Oil Is Tanking

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It’s all about what I call Illusory Perceived Demand. At least that’s what the run-up was all about. The reality is that oil is much closer to its true price. Part of the reason that it has fallen is also attributable to the dollar, which has been remarkably strong given the Treasury’s efforts to completely discredit it as a legitimate currency as of late. But we’ll talk about the incredible inflationary cycle that we’re about to undergo another time.

For now, let’s focus on oil, which was fallen as of today to under $70/barrel, from a high of around $150 as recently as this summer. In the past month alone, the value of crude has fallen by more than thirty percent. So why is oil falling so quickly?

It’s easy to blame the Hedgies, day-traders and speculators, and to say that because they have now been forced out of the market, prices are swiftly falling back to “real” values. But speculators did not cause this, or at least not the type of speculator you have in mind. Rather, actual consumers of oil, the type that purchase these contracts on futures markets, drove up the prices in a bit of a panic. Speculation-in-earnest, not greedy speculation, is the issue here.

The mentality on the futures market has been, until recently, that a massive, amorphous being called CHINA would absorb each and every drop of oil in the world unless Western companies could thwart them by consistently raising the stakes. Because “China” would pay almost anything to continue its stunning growth trend fueled largely by oil, American companies perceived that there was a massive and unquenchable demand afoot that forced them to pay ever-higher premiums to receive the oil they needed to operate. So they accepted rapidly rising oil prices as a geopolitical absolute, and continued to suck down as much of the stuff as they could possibly afford (to the economics student, right up to where marginal cost equals marginal revenue, most especially in the airline industry).

But the reality that is now prevailing in the commodities market is that China is not, indeed, insatiable. Furthermore, their economic system, although difficult for many to understand, doesn’t result in an unlimited supply of wealth with which to buy energy. Further still, their growth is not a phenomenon that will continue to gain speed no matter what. Just as America and Europe are undergoing a recessionary period at this point thanks to the recent liquidity crisis, China is facing a rocky road. Perhaps China is even worse off than America, for instance, since China is so dependent upon Western consumption to maintain its level of growth.

So the boggart has been put back in the armoire, and appropriately so: by enough people standing up to declare the current situation to be ridiculous. The market is soaked in oil, with new production coming out of every spigot at this point. Even the largest nightmares are eventually wiped away as the rational thinkers in the market begin to wake up and question exactly what makes oil almost thrice as valuable as it was just a couple years ago. China is, in fact, a normal player on the world stage, following the same rules of consumption that the rest of us follow. And oil is not in such dire low supply as to be gone within a decade. Even worse for the naysayers, watching oil prices fly so high resulted in many new fields and techniques being discussed anew for where additional oil may reside but be too expensive presently to drill out.

This isn’t to say “Drill Here Drill Now” is the end-all solution to long-term energy needs for this country or the world. Gas will not be, though, obsolete by this time next year. The decision to move to new sources of energy en masse will be made either politically, where citizens decide that they prefer short-term economic inefficiencies for purposes of national security or environmental wellfare, or it will be made economically, when oil supplies truly are outstripped by demand in the long-run.

Unfortunately, the huge run-up and present crash of oil prices is not that dissimilar from the scenario we’ll see when all of this unabsorbed liquidity catches up with the markets. The idea that credit is unavailable is almost absurd. Rather, bankers are claiming that the liquidity flowing out of the fire hydrants is poisoned. When the market quits thrashing about in hysterics and sets to the task of absorbing these funds, they will find money laying about in true excess. This will lead to massive inflation, unless the Fed can perfectly thread a needle that’s almost impossible to read. But we’ll cover that later.

Written by caseyayers

22 October, 2008 at 3:38 pm

On the Subject of Texas Tea

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Originally posted in April of 2006, this piece hopefully still provides some useful information today.

Let’s do a little rundown on gas prices and the like. Not only might it be educational for everyone involved, but it’s indirectly helping me feel prepared for my Economics exam later today.

So Why are Gas Prices so High?

There are several reasons for this.

  • Worldwide Demand is Increasing
    For a while, the United States has been far and away the largest consumer of oil. That- perhaps odious- record is on its way out the door. India and China, the world’s two fastest growing economies (ours being the bronze medal winner by any fair standard) have spurred a massive demand for oil in that part of the world that was not once there. Think of China for a minute. When you picture the Chinese people in the city, how do you see them getting around? In the past, the answer has always been bicycles, right? No longer. Regardless of the social oppression weighed on its people by the Chinese government, China’s people have gotten financially more wealthy in the past decade, to the point where luxuries like automobiles are becoming an imminent reality for millions. The same goes for India. That’s just a minor example, though. Think of all the factories in India and China, and imagine what they run on: oil. And oil isn’t just for energy. It is refined or used in producing lubricants of all sorts- from the things that make machines work all the way down to Vaseline- as well as CDs, carpeting, and a million other things. Simply put, as the whole world wants more stuff- China and India in particular- the price of oil will continue to rise.

  • Refinery Capacity is too Low
    Another contributing factor is the fact that we have a very limited number of ways to turn that black stuff out of the ground into car-friendly gasoline. To do so requires heavy refining, as well as mixing the oil with any number of chemicals for efficiency or environmental reasons. Here’s the problem: we haven’t built a new refinery capable of making gasoline since the 1970s. It’s pretty absurd to think that demand for oil hasn’t risen in the last forty years. It’s even more absurd that supply has been bottlenecked by these old refineries.

    So why haven’t we built any new refineries?

    The environmental types would have you believe that the Earth’s imminent demise is only one more oil refinery away from happening. Of course that notion in itself is absurd, but let’s take a more common sense approach to the situation: if we haven’t built any of these refineries since the 1970s, they must be pretty broken-down and dirty places, right? Of course. The pollution levels are very high from these facilities. Common sense tells me that decades of research would allow us to make a far cleaner-burning refinery today, one that would actually help the environment in comparison with what is running now. So let’s say, just for simple math, that a refinery built this very moment would only release half as much pollution to make the same amount of gas as one of the old refineries does. Great! Let’s build twenty of them. As we turn the new refineries online, we simply turn the old ones off. Same amount of pollution, double the capacity. Using the same reasoning, we could build, say, fifteen of the new refineries. That would actually lower the pollution levels from refineries by 25%, while still raising capacity by 50%.

    You said other things make the gas expensive as well. These chemicals?

    Yep. Ethanol’s a prime candidate for discussion. A lot of people look at Ethanol and see the great “ANSWER” to oil. Ethanol is made from corn, switchgrass, agricultural waste and many other types of plants. The process to create ethanol is very similar to making beer. In fact, Coors has an ethanol plant in Colorado, believe it or not. Ethanol burns cleaner than gasoline (though not much) and is theoretically unlimited. After all, if it comes from corn, we can simply grow more corn when we need more gas, right?

    Not so fast.

    First of all, ethanol is very expensive to make. The only reason it is surviving on the market at all right now is because the federal government has given billions of dollars in subsidies to farmers and ethanol producers to lower the price to the point that it can begin to compete with gasoline in some areas. Secondly, we can’t make enough. The idea of simply growing more corn sounds great at first, but the problem is scarcity. Just like there’s a limited amount of oil in the ground, there’s a limited amount of ground. It would take somewhere around three times ALL the arable land in the United States to grow the corn required to keep up with demand for ethanol if it replaced oil entirely. Lastly- and here’s the kicker- a large amount of oil is used to make ethanol. Think of the tractor that the farmer uses when tending to the corn, the machine that husks it, the truck that drives it to the refinery, the power plant that keeps the refinery going, the truck that takes the ethanol to the distribution center, et cetera. The sad fact of the matter is it takes almost a gallon of oil to make a gallon of ethanol, and ethanol is no more efficient when used later on. All that is happening is we’re paying for the oil twice over with ethanol- once for the oil needed to make it and again for the ethanol itself.

    But aren’t the oil companies taking massive profits on gas sales?

    Nope. You know that “obscene” profit of thirty-something billion dollars ExxonMobil made last year? Congressmen and Senators are calling that a travesty, unpatriotic, blah, blah, blah. Sure, I’d love to have $30+ billion dollars laying around, but the fact is that ExxonMobil and other such oil companies aren’t simply sitting on that money or filling swimming pools with $100 bills. In the last five years, Exxon has invested over $74 billion dollars in new oil finds. The fact is it is really expensive to start up a new oil pipeline or off-shore drilling platform, much less to find the stuff in the first place or turn it into usable gas. The fact of the matter is that every time Exxon simply GUESSES where oil might be, it takes over ten million dollars just to poke the hole in the ground to check. Even worse is the fact that we aren’t letting them actually go to where we know the oil is, like off of the west coast of Florida or that small patch of hell in Alaska.

    Here’s another point- the typical margin for gasoline sales is maybe 10% for oil companies. That means when you pull up to the BP or Shell down the street, even at three bucks a gallon, they’re only pocketing maybe 30ยข per gallon. Here’s the dirty little secret- the government, between federal, state and local, collects over fifty cents per gallon. That means that the government- remember, the ones calling the oil company profits obscene- are actually pocketing almost 70% more than they are. The government would claim that that money is needed to build roads. Without getting into a usage argument, I’ll agree with that, but say that the oil companies need their profits just the same to be able to invest in finding other oil supplies around the globe to make sure we don’t run out.

    But isn’t oil bad for the environment?

    Sure. I won’t argue that point. I get angry every time I see one of those dump trucks outside of UNF spew a tower of black smoke out of the top. However, what is the answer, exactly?

    Well, for those of you environmentally inclined, you should welcome the rise in prices wholeheartedly. The fact of the matter is that $3 a gallon is just about where hybrid cars begin to pay for themselves in gas savings. Hybrids obviously use less oil and are all much less polluting than standard vehicles. But are they the answer? No. Remember when I said that China and India are starting to drive? The fact is the number of cars on the roads of the world is increasing at such a rate that even if the entire country switched to hybrids this very moment, within ten years our oil consumption would be right back to where we are today.

    So what do we do to fix this once and for all? First of all, we need to start getting rid of our power plants that run on oil and coal. We replace them with nuclear power, as well as photovoltaic solar plants when the technology is ripe enough in ten to twenty years.

    Wait, isn’t nuclear power a scary thing that will end us all?

    I dunno. How about we ask Peter Moore, the founder of GreenPeace? The fact is that nuclear power is incredibly safe now, especially with advances in the technology made in the last twenty years. You know, the twenty years in which we haven’t built any nuclear power plants. Do you think the French, perhaps, are environmentally attuned? I do too; they produce almost all of their power through nuclear technology.

    So you were saying about how to stop using so much oil?

    Yes. Don’t interrupt me.

    Sorry.

    Right then. So the first step, as I said, is to get rid of those power plants. They take up a huge amount of oil and coal and release a lot of pollutants. Now what about our automobiles? I’ve already explained why ethanol is not an answer in any way, shape or form. So what’s the golden goose? Hydrogen. By 2009, the first hydrogen-based cars will begin rolling off of the lines from makers like GM. Running on a relatively simple chemical reaction, the only emission from the system is water. Cool, huh? Well, the only problem is they currently have the tendency to explode. Once GM and the others get the technology down, though, it has the power to truly make gasoline obsolete.

    So where can I fill up with hydrogen? I only remember seeing 87, 89, and 93 octane at the pumps last week…

    Good point. It’s a chicken-and-egg scenario, isn’t it? There’s no cars that use hydrogen, so why build the (very expensive) pumps? At the same time, why build cars that people can’t use?

    You’ll love the answer to this one.

    You know those record profits the “oil” companies are making? Companies like Shell are reinvesting a piece of those in promoting hydrogen technologies as well. Think about it from their perspective- they know oil’s days are numbered, so to remain a viable company, they have to lead the way to the future. So for each obscene billion dollars of extra profit, the “oil”- perhaps “energy” is a better term- companies are reinvesting that not only in finding new oil, but also in developing oil’s replacement. It’s all rather elegant, hm?

    That’s all very nice, but I’m tired of paying so much right now. What’s the deal?

    Well, I’m sorry. The fact is that if you’re not willing to pay the price, the Chinese and others are. Oil demand has risen with no subsequent rise in supply. The solution? Get mad. Start making people aware of the fact that we can’t even make any more gas than we are right now. Understand the fact that the government is taking a far larger piece of profit out of every gallon than the oil companies are. Thwart any legislation against “windfall profits” that are being used to develop cheaper and safer energy sources. And, sorry folks, just drive a little less.

  • Written by caseyayers

    25 April, 2006 at 11:34 pm