Diatribes of Jay

This is a blog of essays on public policy. It shuns ideology and applies facts, logic and math to economic, social and political problems. It has a subject-matter index, a list of recent posts, and permalinks at the ends of posts. Comments are moderated and may take time to appear. Note: Profile updated 4/7/12

15 December 2010

Four Dollars a Gallon by Next Summer

[For an update on this post as of 1/6/11, click here. For comment on John Boehner’s crocodile tears, click here. For comment on our own “reds” and their future, click here.]

How quickly they forget. In June and July of 2008, when we all knew home prices would go up forever, the price of gasoline rose above $4 per gallon [Footnote 1] for the first time ever. Diesel fuel nearly hit $5. Suburbanites were hurting, and truckers blocked streets in D.C. in protest.

Just six months later, regular gas had dropped from its peak of $4.05 to a low of $1.59, which it reached on December 29, 2008. That’s a plunge of over sixty percent—almost two thirds.

What caused the drop? Did some massive new supply of oil miraculously appear? Did the brilliant economic policies of Dubya’s administration, which presided over the second-greatest global economic collapse in human history, suddenly solve our four-decade-old energy “crisis”? Had nefarious speculators caused the high prices, as demagogues on both sides railed?

No, no, and no. The answer, dear reader, was none of these. It was Economics 1A: the law of supply and demand.

So many people who really should have known better failed this test of cause and effect. As I’ve argued before (in one of my best posts), we Americans are innumerate. Culturally speaking, algebra and calculus are utterly beyond our ken, because most of our leaders are lawyers. They went to law school because they hate math.

As a culture, we can’t even do arithmetic very well. But we can learn. So let’s run some simple numbers.

But first, let’s review some key facts about economics and gasoline. There’s a key economic variable called “inelasticity.” A commodity is said to be “inelastic” when its price varies widely (and wildly) with changes in demand. This is what happens when people can’t do without it, and there are no good substitutes to which they can switch. As demand goes up, people can’t stop using the commodity or switch to cheaper substitutes, so its price skyrockets. The price jumps push poorer people out of the market entirely; they do without. If demand falls, the price plummets, unless supply contracts too.

Gasoline and the oil it comes from are two of the most inelastic commodities known to economics. Outside of a few dense cities like Chicago, New York, or San Francisco, just try getting to work or the supermarket without your car. And what about substitutes? Can you put cooking oil or fat drippings from your stove in your gas tank? Try that, and you’ll ruin your engine. You can’t even run ordinary engines on natural gas or a blend containing more than about 25% ethanol. You need engine modifications even for such close substitutes.

These facts are not as true everywhere in the world. A few foreign countries have decent, high-speed rail systems and good public transit. France has cheap and pollution-free electricity, 77% of which comes from the atom, which it can use for electric cars. Brazil has flex-fuel vehicles. But the rest of the world, including the worst offender (us), relies on gasoline alone to transport goods and people, even where they call it “petrol.” Most places have no substitutes.

Worse yet, the entire world is now investing massively in a race to make oil and gasoline even more inelastic. Every increase in car production and sales, every new plant for manufacturing internal combustion engines, every new freeway designed for oil-fired cars—all these things increase the inelasticity of oil as a commodity. Only the electric car, flex-fuel vehicles, and electrified railroads provide any hope for relief. Electric and flex-fuel cars can use some of the same manufacturing plants and the same roads as gasoline-fueled cars.

Unfortunately, we Americans are the most vulnerable to the price shocks produced by inelasticity and increases in demand. As our own Department of Energy summarizes, “Canada and the United States stand almost alone in their consumption of oil per capita[,]" as shown in a helpful graph. Our per-capita consumption of oil is over eleven times that of non-industrialized countries, including China.

Now we have the basic facts: a global economy in which gasoline may be the most inelastic commodity in common use (and is getting more inelastic every day), and in which we are most vulnerable to resulting price shocks.

So what caused the merciful drop in gasoline prices at about the same time as the global economy collapsed? Was it coincidence? Did the oil god take pity on us poor mortals suffering from a bursting real-estate bubble? Did speculators relent?

Not hardly. The two phenomena were cause and effect. The global economic collapse reduced demand for oil [Footnote 2] by about 2%, and the price of gasoline fell by 60%, with oil prices falling accordingly. That’s inelasticity.

Now the global economy is recovering, even here at home. So what does that mean? Well, let’s do some simple arithmetic. For the entire OECD, which includes us, the projected GDP growth rate for next year is 2.7%. [Open “Economic Projections” and drill down to “Economic Outlook No 88 - Dec. 2010”] This figure is probably low, since it projects our own rate at 2.2%, while our more recent projections are for 2.6%. But let’s be conservative and say just 2.7% for the whole OECD, including us.

The rest of the world isn’t growing so slowly. Projected growth rates for China and India are 8%. And China’s rate accounts for what China’s leaders expect to be a “slowdown” to avoid a real-property bubble there.

Now the OECD countries account for about two-thirds of global oil consumption. Together, China and India account for a little less than 40% of global population. So they probably account for about the same share of the rest of global oil demand, i.e., 40% of one-third, or about 13%.

Let’s make the reasonable assumption that growth in oil consumption is proportional to growth in GDP. Let’s also assume that the rest of the world, which accounts for the remaining 20% of global oil consumption, is growing, as global economic recovery continues, at a rate midway between the OECD’s and China-India’s rates, that is (2.7 + 8)/2 or 5.3% (rounded down). Then consumption-weighted global growth in oil demand will be (2.7*.67 + 8*.13 + 5.3*.20) = 3.9%.

Now let’s look at the supply side. Our own Energy Department projects non-OPEC supply as decreasing by 0.28 mbb/d (million barrels per day) in 2011. OPEC supply is supposed to increase by a maximum of 0.4 mbb/d. That’s a maximum net increase of 0.12 mbb/d. As compared to 2010 average global demand of 87.3 mbb/d, that’s less than a 0.14% increase. So the projected increase in demand, less the projected increase in supply, is 3.9% - 0.14%, or 3.76%.

So in less than seven months (2/3.76 x 12 = 6.4 months), the global economy should have made up the shortfall in demand that appears to have dropped gas prices from $4.05 to $1.59. In theory, getting back to $4 a gallon should take even less time than this, as the price is already just two cents shy of $3 per gallon.

Our Energy Department’s projections provide a more optimistic estimate. The DOE projects (by other means not stated) global demand growth for oil in 2011 at 1.4 mbb/d, or about 1.6% of 2010 average daily demand (87.3 mmb/d), for a deficit in supply of only 1.46%. At that rate it would take (2/1.46 x 12) or about 16.4 months to get back to $4 per gallon.

But what if the DOE’s estimates of net global demand growth are low? OPEC’s surplus capacity is supposed to be 5 mbb/d. Even at the DOE’s lower rate of demand growth, that’s 5/1.4 or only about 3.6 years of slack at 2011 growth rates. Now recall that the DOE projects non-OPEC supply to fall in 2011.

And please don’t wave your hands and mumble “new oil.” There isn’t a single major new oil discovery anywhere in the world that can produce significant gasoline at the pump in 3.6 years, let alone seven months. Most of the new oil is in deep water. If nothing else, the Great BP Oil Spill proved that thinking of it as gas at the pump exaggerates our human capabilities and underestimates risk and cost.

As for other explanations for the recent price rise, alleged refining bottlenecks are not the answer. Refining bottlenecks don’t explain recent price increases. As oil has risen from $70 per barrel to over $90 now—a rise of more than 28%—gas has gone from around $2.70 to just over $3.00—a rise of about 11%. If refining bottlenecks were the problem, gas prices would go up faster than oil prices, not vice versa. And anyway most of the recent rise in gas prices occurred as winter approaches—hardly a time of maximum driving. That fact, too, suggests that oil price rises are the underlying cause.

Maybe my less-than-seven-month projection is wrong, and the over-sixteen-month projection based on the DOE’s numbers is right. Let’s hope so. In the best of all possible worlds, with OPEC cooperating fully and not overestimating its reserve capacity, with no unexpected spikes in demand, and with no unexpected shortfalls in supply (for example, due to war in the Middle East), it might take as many as three or four years to get back to $4 a gallon for gas.

But what if global economic growth accelerates, OPEC refuses to cooperate, and/or something bad and unexpected happens, like a boycott or war in the Middle East? Only we and Europe are still hobbled by the aftermath of the 2008 derivatives debacle. For the rest of the world, the sky may be the limit on growth.

What if, as my calculations suggest, $4 gas takes far less than two years to return? Gas is already back to nearly $3 per gallon, and it’s easy to see it moving up another 33% to $4, especially when a 2% drop in demand apparently caused the price to drop over 60% in late 2008.

If my assumptions and arithmetic are right, and if OPEC can’t or won’t prevent, we will have $4 a gallon gas again by next summer. If that happens, and if gas stays over $4 during the 2012 election campaign, the President will be a one-termer.

Far more than any campaign contributor—let alone ordinary voters—OPEC can retain or dismiss the President in 2012 simply by turning the oil tap on or off. And if my less optimistic (than the DOE’s) 3.9% estimate of global oil demand growth is accurate, the world will outrun OPEC’s estimated 5 mbb/d reserve capacity in 5/(87.3*.039) = 1.47 years, with 2010 demand of 87.3 mbb/d as a baseline. Once that happens, gas will exceed $4 a gallon in another seven months—for a total of 25 months—no matter what OPEC does.

No one—not even the most optimistic economists—expects employment to have recovered by then. If truckers blocked traffic during the still-booming summer of 2008, think what mood they and the public will be in when diesel is over $5 again, over fifteen million people are still unemployed, and millions have lost their homes to foreclosure. Then think what will happen to our economy.

If members of Congress consider this year’s Tea Mob Revolt rough, maybe they ain’t seen nothin’ yet.

So my conclusion is simple. Being a Socratic sort, I’ll express it as a question: isn’t it time to get serious about energy? The long term is no longer long; it’s here now.

Footnote 1: All gasoline prices in this post are for regular gas and come from the Department of Energy’s official website. You can access current prices through this page and historical prices through this link. Just click on “Regular” under “Grade,” download the spreadsheet, and open it in Excel or OpenOffice (which I use). My figures are from the left-hand column, labeled “Weekly U.S. Regular Conventional Gasoline Retail Prices.” Other figures are regional averages. (I assume “conventional” excludes ethanol blends.)

Footnote 2: It’s hard for an outsider like me to get a precise estimate of the drop in global demand for oil that caused the price drop during the Crash of 2008. I could find no weekly figures corresponding to those for gas prices in Footnote 1. In any event, responses in the price of gasoline to demand for oil are probably not immediate. They probably take a month or more, assuming no intervening change in supply by OPEC.

But we can estimate the general level of demand drop from this graph. The average 2008 demand was 86.1 million barrels per day, and it dropped to 84.4 in the first quarter of 2009. That’s a drop of 1.7/86.1, or just under two percent.

Update to Main Post (1/6/11)

Today the New York Times posted a story about our car industry’s partial success in increasing the gas mileage of its collective fleet while still making a profit, largely by reducing the size and weight of its vehicles. The headline, “The Downsizing in Detroit,” wasn’t much news to anyone who’s followed our industry’s struggle to survive over the last several years.

But the story contained two pieces of important news. First, GM CEO Dan Akerson reportedly told his car-design managers to “to plan for oil at $120 a barrel and gasoline at more than $4 a gallon[.]” Since the auto industry typically takes two years from design to production—three if you include time from concept to design—it appears that Akerson’s own time frame is consistent with the more optimistic conclusions from my arithmetic above. That is, it appears to assume that OPEC will use all of its spare capacity to keep oil prices low as long as it can.

Having my calculations confirmed in part by the executive responsible for the auto-industry icon most recently returned from the dead gave me more confidence in them. I trust that the confirmation was independent, through I did notice recent (and unusual) hits on this blog from GM.

The second bit of news was just as important and perhaps reflected the first. Ford is scheduled to announce an all-electric version of its leading Focus compact tomorrow. This announcement will further complicate my personal buying decision, perhaps adding a third choice to the Volt and the Leaf. But that’s a complication that I, our nation and our species can only applaud.

If the announcement of the all-electric Focus is at all credible, I probably won’t make a final buying decision until late spring or early summer. Needless to say, I’ll post my decision and my reasons on this blog.

Stalin in America?

Josef Stalin was a sentimental man. Often he would cry, in private, after “purging” a friend and comrade who, for reasons real or imagined, had become an enemy of Stalin, and therefore of the State.

It’s hard for ordinary mortals to know what really motivated those tears. People like Stalin are so different from the rest of us as to claim the mantle of another species. He is famous for having said that the greatest human feeling is not love, but revenge. He lived that ethos, decimating his colleagues and causing his people immense pain and suffering. Precisely why he cried after sending long-time comrades to the firing squad or the gulag will forever remain a mystery.

Lenin built the Communist state, with all its internal contradictions. But it took Stalin to institute the Terror and deprive the Soviet Union of any chance of beating fascism easily. The only tyrant who ever rivaled Stalin in magnitude and scale of evil and incompetence was Hitler. Genghis Khan, whose regime was enlightened for its time, didn’t even come close.

Now we have the same specter of crocodile tears from John Boehner, our new Speaker of the House. Not once, but several times. He says he can’t even visit kids—so many of whose lives he has hardened or destroyed—without tearing up. Much of his tears appear to come from self-pity, as his age exaggerates the remembered pain of doing manual labor at odd jobs to get to the point where he could hand out tobacco lobbyists’ checks on the floor of the House. [Set video time to 1:16.]

To say that Boehner is now the most dangerous man in America would be an understatement of Obamanian proportions. As Speaker, he will be third in line for the presidency.

Like Stalin, Boehner enforces party discipline. Like Stalin, he has become quite good at it. He hasn’t yet resorted to physical purges, but he’s used every lever of economic, political and social pressure. Under his leadership, moderate Republicans have nearly become extinct.

Boehner’s ignorance and stupidity in matters economic could rival Stalin’s. Like Stalin, he is a man whose record consistently ignores and steps on common people. God knows what the people of his district, who had a much better alternative, were thinking.

Even our centrist president retains Guantánamo (in part because Boehner exaggerates the dangerousness of prisoners there), continues domestic spying, argues in court for over-the-top secrecy, and won’t investigate the war crimes of his predecessors. So saying “it can’t happen here” is whistling by the graveyard.

There is one clear lesson to be drawn from Boehner’s imminent accession to real national power. The President and Vice President should never travel together. They should never even be in the same city at the same time.

Reds on the Right

A recurrent theme on this blog is the resemblance between the mindless ideology that the GOP has pushed for thirty years and the one that destroyed the Soviet Union. [See 1, 2, 3 and 4.] They differ in economic substance of course, but in methods they are surprisingly similar. The only major difference is that our system emphasizes propaganda more than terror, at least up to now.

I have argued that no one “won” the Cold War. Both sides lost. The War’s mutual paranoia caused each side to dig itself deep into an ideological hole—and away from reality—with ultimately catastrophic consequences.

Of course the ideologies differed in substance. Communism is not the same as fundamentalist, over-the-top capitalism. But both ideologies shared essential methods and means that made them dangerous to national health. Both were “totalitarian” in the sense that they ignored reality, brooked no dissent, and involved “creative” (some would say “fantastic”) rewriting of facts and history.

While the substance of GOP ideology differs from the Soviets’, the methods of enforcing the different lies are chillingly similar. Our propaganda organs, such as Fox, are privately funded, but they could have taught the Soviets a thing or three. The Reds had their commissars in every department of government to enforce the party line on ideology, history and “truth.” Commissars even ruled the factory where the great aircraft designer Tupolev and his team of engineers designed warplanes at the height of World War II.

Under Karl Rove, Dubya’s administration had the same thing: he just called them “political operatives” instead of “commissars.” But they did precisely the same job: (1) spying on their departments and reporting ideological transgressions to political controllers, (2) exercising direct authority outside the chain of command, and (3) owing absolute political loyalty to their ideological masters because of their youth, inexperience and ideological zeal. Our commissars even had their own universities where they received political indoctrination, places like the Orwellian-named “Liberty” University and Oral Roberts’ college of religious indoctrination.

A second characteristic of ideological totalitarianism is the cult of personality. During the Cold War, American scientists used to laugh at how Soviet commissars forced their scientists to begin papers on abstruse fields with several paragraphs of praise for Marxism-Leninism, the Soviet Communist Party, and whoever was then its general secretary. Under Duyba, the surgeon general of the United States was ordered [search for “three times”] to mention Dubya, by name, at least three times on every page of his public speeches.

But word play is the worst and most Orwellian of the mutually observed totalitarian tactics. Just as the Soviets rewrote history and redefined words, so does our GOP and its talented PR operatives. I’ve already written extensively [see 1 and 2] on the redefinition of words, and I won’t repeat that analysis here. But Paul Krugman of the New York Times has just brilliantly summarized how the GOP has rewritten recent history and intends to continue to do so.

In order to blame the Great Economic Collapse of 2008 on government, rather than the unrestrained private banks that actually caused it, GOP dissenters on the Financial Crisis Inquiry Commission have blacklisted words like “deregulation,” “shadow banking,” “interconnection,” and even “Wall Street.” Having disposed of these inconvenient words and the underlying concepts, they concluded that government alone had caused the catastrophe.

Failing to face reality always has consequences. The Soviet Union is no more. Most of its subject (non-Russian) peoples are no longer part of it. They are not even satellites. Instead, they are citizens of separate nations with varying degrees of economic dependence on Russia.

Russia itself has only a fraction of the old Soviet Union’s GDP. It is now engaged in a long and painful struggle to rebuild its industrial base and create a modern industrial infrastructure, including roads throughout its vast territory. The only thing truly modern about it today are its armament and space industries. Even its oil industry, despite large reserves, is technologically backward and dilapidated.

A similar fate awaits us if we continue on our present course. It won’t be the arms race that bankrupts us, although our endless wars, financed by borrowing, surely will help. It will be our profligate use of fossil fuels and our utter dependence on them for our entire transportation infrastructure. You have only to look at this graph to see why. Together with Canada, we use eleven times as much oil per capita as the developing world, including the BRIC countries.

Unless we bind up this Achilles heel soon, it will be the cause of our economic collapse, just as an unwinnable arms race was for the Soviets. The precise trigger of our collapse will be a second banking crisis like that of 2008, brought on by failure to face honestly the causes of the first.

Some time ago, I pooh-poohed a theory of an old Russian KGB man turned professor. He had predicted a breakup of these United States much like the Soviet Union’s.

Now I’m not so sure I was right. Our Constitution is just a piece of paper. When economic powerhouses like California, Illinois, New York and Washington State begin to understand how the so-called “red” states are dragging them down, they may decide to head for the exits and make their own, better economic policy. Our nuclear weapons, evenly distributed around the nation, would avoid another civil war because, as I’ve argued, nuclear weapons keep the peace. So a Soviet-style breakup here, while still unlikely, is far from impossible.

How ironic is the resemblance! Even the nicknames are the same. In the old Cold-War days, we used to call the Communists “Reds” because their banners were red. Now we call the GOP states “red” states.

Whoever thought up that color scheme must have been clairvoyant. We Democrats are “blue” because we continue to lose despite having far better contact with reality. The “reds,” with a propaganda machine unmatched in human history, are winning. They’re not the old Russian or Soviet Reds, but our own reds on the right. Yet their “victory” will be a pyrrhic one, just as was the Soviets’, even if it takes another seventy years for the tragedy to play itself out.

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