GAS MATH

The Republican contenders for president, Newt Gingrich in particular, have been attacking President Obama for not doing enough to bring down oil prices. This sounds great on the campaign trail, but it doesn’t have much to do with economic reality.

Current world oil consumption is 80 million barrels per day. The US consumes 21 million barrels per day, or approximately 25% of world consumption. Current projections are that world consumption will increase to 100 million barrels per day in the next decade, but that US consumption will remain the same or may decline slightly, so we will consume “only” 20% of world consumption. (Just to put things in perspective, the US population is approximately 5% of world population.)

Current US oil production is 9.5 million barrels per day. (We export 1.9 million barrels per day, but that is largely refined products, not crude oil.) We have to import 13.5 million barrels of crude per day to make up the net difference. (At $100 per barrel, that comes out to 1.35 billion dollars every day that flows out of our country – just to buy oil.)

Approximately 60% of the price of gasoline is entirely controlled by the world market price for oil. A barrel of oil is 42 gallons. If oil costs $100 per barrel, that translates to $2.38 per gallon just to buy the oil. (Crude doesn’t all cost the same. I checked today and West Texas Intermediate Crude was selling for $106 per barrel. North Sea Brent was selling for $123 per barrel. At $106 per barrel, that means the gasoline costs $2.52 per gallon just to buy the crude oil. At $123 per barrel, it costs $2.93 just to buy the crude.)

The remaining 40% of the price of gasoline basically consists of transportation costs, refining costs, state and local taxes, advertising and other corporate expenses, and corporate profits.

Transportation costs include the cost of transporting crude oil to the refinery and the cost of transporting gasoline from the refinery to the gas pump. Obviously, transporting crude oil from the Middle East to US refineries costs more than transporting crude oil from west Texas to Port Arthur, Texas. But, and pay attention here, by far the largest single source of US oil imports is Canada, not the Middle East. Mexico and Saudi Arabia are in a near tie for second. (Nigeria and Venezuela round out the top five.) The largest sources of US oil imports are our next door neighbors here in North America, not “countries that hate us” in the Middle East.

Refining costs depend primarily on the quality of the crude and where the crude is located in the ground. Oil shale is much more costly to refine than the benchmark “light, sweet crude” that comes from the Middle East or “intermediate crude” from Texas. (Less impurities, lower sulphur content, etc.) Oil that comes out of a well deep under ground and deep under water is far more expensive to produce and transport to a refinery than oil that is near the surface on land.

Taxes can be as much as 68 cents per gallon. For instance, state taxes are currently as high as 49.6 cents in Connecticut and as low as 8 cents in Alaska. The current federal tax rate is 18.4 cents per gallon.

I’m not sure why oil companies see the need to advertise so much. I buy my “gas” at Shell because I drive a large diesel truck and in Texas, Shell stations sell diesel. There is a Shell on the way to my office (and on my way home). I have no particular love for Shell, this is just a practical reality for me. Advertising by oil companies has no effect on where I buy my fuel, but they advertise (extensively) nonetheless. I know a lot of people who buy fuel on the same basis. (Decent price, near home.)

Don’t discount corporate profits. I am very much a believer in corporate profits. I own my own law firm. My profit is my paycheck, so the higher the profit, the higher my paycheck. BUT the oil companies make billions of dollars in profits which they pay out to their shareholders. The reality is those billion of dollars cost you at the pump.

 

The reason gas prices have spiked recently is claimed to be because of (1) disruptions in supply from the Middle East and (2) future uncertainty in the Middle East. The first reason appears to be largely a perception rather than reality. Oil supplies from the Middle East have seen no significant recent reductions. (Germany and France have indicated that they will stop buying oil from Iran, but they will buy it somewhere else and China will buy more oil from Iran. Oil is oil. It doesn’t come with a “Made in Iran” label.) The second reason is pure speculation and appears to be the real source of the recent increase in gas prices. (IF the US or Israel attacks Iran, it MIGHT interrupt the flow of oil from Iran, which is a significant but not a huge contributor to the world supply.) What has happened recently is that the price of oil has increased although the cost of oil is essentially unchanged.

Many of the Republicans have advocated a “drill, baby, drill” policy to increase oil production. Sounds good, but the amount of oil produced will be incremental and it won’t reach the pumps any time soon. Assume we approved drilling in the Arctic National Wildlife Refuge tomorrow. This is really, truly in the middle of nowhere. Hundreds of miles from the nearest roads. Which are only driveable in the winter, when they are frozen. (The rest of the year it’s too swampy to haul a rig across.) After you haul in the rig, you still have to build a small pipeline to get the oil from the well to the big pipeline. And you have to do it for each well. North of the Arctic Circle. Could somebody kindly explain to me how that is going to reduce the price of gasoline to $2.50 by the end of 2013? (Newt’s promise, although lately, he has been blaming Presidebt Obama because gas costs mor the $2 per gallon.

By the way, the number of operating rigs in the US is currently approximately 2,000. That is the highest number since – guess when – 1985. (When Ronald Reagan was president.) If “drill, baby, drill” is the plan, we are already implementing that plan. Also, by the way, the world rig count is about 3,750, also the highest number since 1985. The reason is simple – higher crude prices justify higher production costs. It has nothing to do with who is president – Reagan or Obama. (Or Gingrich, or……….)

Some Republicans have also criticized President Obama for delaying approval of the Keystone Pipeline which would run 2147 miles from the oil sands in Canada to refineries on the Gulf Coast of Texas. (I say “some” Republicans because Republican landowners in Nebraska are adamantly opposed to the pipeline. For them, it is a property rights issue.) Estimated time to completion (minimum) is three years. Reality is probably longer.

Republicans also advocate increasing offshore drilling both in the Gulf of Mexico and off the coast of California. California opposes this, by the way. (Whatever happened to state’s rights?) Drilling offshore also takes time. Once the government issues the leases, the oil companies have to evaluate the leases through seismic testing, then haul in the deepwater rigs, then drill, then build a pipeline to shore. (Unless they are going to haul it in tankers.) All of this takes time. (Like several years.)

The other issue is that none of these sources by themselves will result in a significant increase in world oil supply. Each of these sources will increase world supply by less than 1% when they come online. With that said, 1/2% here and 1/4% there and 1/6% over there, and we might increase world oil production by maybe 10%. 10% is definitely something to think about, but remember, world oil consumption is expected to increase 25 % (from 80 million barrels to 100 million barrels) in the next decade. The US simply cannot become oil independent by increasing production. We would have to increase production by 150% over current levels. There just isn’t that much untapped production out there. The cheap oil has all been discovered and has been produced or is in production. (Texas, the shallow Gulf of Mexico, the Middle East, Nigeria.) Future “new” sources of oil production will be in deep waters offshore, north of the Arctic Circle (Alaska, Canada, Siberia) or in “developing” countries with unstable political systems. (Nigeria is the poster child.)

So what can the president (not just President Obama, but any president) do to lower gas prices in the short run? He could ask for a temporary decrease in state and federal fuel taxes until the market price for crude drops. But Congress (and the states) would have to approve any such decrease and the House has opposed the temporary “tax holiday” for payroll taxes, so a tax holiday for gas taxes seems unlikely. The states are all facing budget shortfalls, so they are also unlikely to agree to a decrease in tax revenues. The second thing the president could do is release the oil stored in the Strategic Petroleum Reserve. That sounds good, but the Strategic Petroleum Reserve contains 30 million barrels of oil. 30 million barrels of oil sounds like a lot, but the US consumes 21 million barrels per day, so 30 million barrels is 1 ½ days worth of US consumption. (It doesn’t work like that. They might release 500,000 barrels per day, but that would only reduce our imports to 13 million barrels per day and it would only last 60 days.)

In the long run, the president can raise the CAFÉ standards for autos manufactured in the US. “CAFÉ” stands for Corporate Average Fuel Economy. President Obama has already raised the CAFÉ standards, by more than any other president ever. He also imposed “truth in advertising.” Until he changed the rules, the CAFÉ standards did not include trucks which typically get lower gas mileage, so “corporate average” stood for “corporate average, but not for all the stuff we make.” Big business always claims raising the CAFÉ standards will cost jobs, but since President Obama announced higher CAFE standards, GM posted its biggest profit ever in its history. (This is what we call a “disconnect.”) Raising the CAFÉ standards will do nothing to increase the supply of oil, but will decrease the demand for oil. The long term effect will be to reduce US oil consumption and imports, but world consumption will continue to increase, so gasoline prices will no doubt continue to rise, as well.

The real problem is that the US has never had any real energy policy in my lifetime. (Other than use as much as you want, whenever you want.) “Drill, baby, drill” is a slogan on a bumper sticker, not an energy policy. The Strategic Petroleum Reserve is a good idea, but it needs to be 300 million barrels, not 30 million. (300 million barrels is still less than a 15 day supply.) $2.50 gasoline is a campaign promise that will not happen. This is not the fault of the Republicans or the Democrats. Both parties have failed miserably on this issue. (Crude prices would have to drop to about $70 per barrel. Not likely given current and projected consumption.)

The truth is that the responsibility for this mess falls on the American people, because WE have not required our elected representatives to act on this vitally important issue. So what can WE do? There are several things Americans can do to decrease our dependence on foreign oil. None of them will be fun. Some of them will require actual “sacrifice.”

First, and by far the single biggest thing we can do, is drive more fuel efficient vehicles. The increasing number of hybrid vehicles is a good start. Electric cars (for people with shorter commutes) will also help. Higher CAFÉ standards (which phase in over time) will make a significant dent. But we also need to accept the fact that we don’t all “need” a Hummer or a Tahoe or an F-350. I understand that you need to haul kids to sports and groceries from the store and golf clubs to the country club, but a Jetta wagon will actually haul all of that stuff, and at double (or more) the mpg. We also need to get over the ego aspect of car ownership. It’s a car. It’s a means of transportation. You need it to get from point A to point B safely and on time. (If you need a car to prove your self worth, there is something wrong with your self worth.)

T. Boone Pickens, a Texas oil man, has been advocating for years that we switch from oil to natural gas where possible. He argues that natural gas is abundant here, so we don’t have to import it. We have huge reserves. The consensus is that the US has a 100 year plus supply. And natural gas prices are at a ten year low. The problem is making the transition. We don’t have the infrastructure to switch in any kind of a hurry, but Mr. Pickens has an answer for that, too. He suggests that we convert large fleet vehicles that get terrible mileage to natural gas. This includes 18 wheelers, school buses, and city buses. (Most of these vehicles run on diesel and get maybe 5 miles per gallon.) They are relatively easy and inexpensive to covert to natural gas. The infrastructure burden is less, because the school buses and city buses go back to a “bus barn” every night, so they could put in the fueling stations at the bus barns. 18 wheelers generally fuel at truck stops, not at neighborhood gas stations, so building the fueling capacity is manageable. The reality is that it will take time and there may have to be tax credits to “encourage” the transition, but it would result in a major decrease in oil consumption over a relatively short period of time. And it wouldn’t hurt our balance of trade, either. Remember, we spend $1,350,000,000 every day to import crude oil. (That’s almost $500 billion per year.) Not only does that number drop, but more of the money stays here. We would have to drill more gas wells. We would have to build pipelines to get the gas to a distribution facility. We would have to build new fueling stations.

In the interest of full disclosure, I drive a Ford F-350. I “need” a big truck because I own a ranch and I have to be able to haul a trailer, or fence posts, or….. I also own 11 kayaks (I teach lessons), and they won’t fit in the trunk of my Nissan Altima. (Which my son drives.) BUT, and this is significant, I typically drive less than 10 miles per day. It is three miles one way from my office to my house. The grocery store and Lowe’s are a slight detour, and I make an effort to stop on the way home from work. My truck gets terrible gas mileage (14 mpg), but if I only drive seven miles per day, that’s half a gallon in a typical day, or $2.

By the way, the cost of gasoline in most of Europe is $10 per gallon or more so most of the cars over there get closer to 50 mpg.

Michael Baumer

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by Michael Baumer