Bits and pieces from today’s news, including more than you probably wanted to know about switch grass. Also, Neutral Source has dredged up November 2005 Federal Trade Commission testimony in response to the last time Members of Congress alleged nefarious conduct in the gasoline business.
Here are the latest data from the Energy Information Administration. Over the past week, average retail gasoline prices declined 1 cent per gallon for the week. Significant declines are observed in the New York spot market.
EIA predicts that high oil prices will be sustained:
EIA’s analysis of current oil market conditions has led us to believe that there are three major factors that have caused the price of West Texas Intermediate to go from $20 to $30 per barrel in 2000-2002 to over $70 per barrel the last couple of weeks. In no particular order, they are: 1) strong global demand growth, especially in China and the United States, 2) limited surplus capacity, both upstream and downstream, and 3) major weather and geopolitical risks that have highlighted the need for more surplus capacity, both upstream and downstream. If EIA is correct in its analysis that these are the major factors driving oil prices right now, then it is logical to assume that oil prices will stay at high levels until current concerns are eased in one or more of these areas.
EIA’s analysis does not address the sudden increase in gasoline prices that occurred in April.
On May 8 Sen. Dianne Feinstein (D-CA) filed S. 2760 on behalf of herself and Sens. John Kyl (R-AZ) and John Sununu (R-NH). When the bill was announced on May 5, it was not clear if it would eliminate or temporarily suspend the ethanol duty. S. 2760 would eliminate it.
The entire text of the bill is below with a hyperlink to the referenced document:
SECTION 1. DUTY FREE TREATMENT FOR IMPORTED ETHANOL USED FOR FUEL.
(a) IN GENERAL.—Subchapter I of chapter 99 of the 6 Harmonized Tariff Schedule of the United States is amended by striking heading 9901.00.50 and any U.S. note relating to that heading.
(b) EFFECTIVE DATE.—The amendment made by this subsection applies to goods entered, or withdrawn from warehouse for consumption, on or after the 15th day after the date of the enactment of this Act.
The current duty is 14.27 cents per liter, or 54.05 cents per gallon.
Meanwhile, the effect of ethanol subsidies is garnering more attention. Cargill Corp. chairman and CEO Warren Staley is quoted criticizing these subsidies for diverting corn from food to fuel:
“We have to look at the hierarchy of value for agricultural land use: food first, then feed and last fuel. Today we are providing subsidy to fuel uses while often erecting barriers to new food and feed technologies,” Staley said.
Archer Daniels Midland chairman G. Allen Andreas says food production can be outsourced to Brazil:
“There’s plenty of capacity to make food,” Andreas said, noting there were “hundreds of millions of acres of land in Brazil” that could be developed into farmland.
The Renewable Fuels Association, the ethanol industry’s trade association, is critical of President Bush’s proposal to eliminate the 54 cent per gallon import duty, which S. 2760 would do. The Fox News account quotes an RFA spokesman offering a logically inconsistent defense: the import tariff should not be eliminated because no additional ethanol is needed and Brazil can’t provide it:
Bush’s proposal sparked a backlash. “Once you peel away the layers of the onion on this issue you realize it doesn’t make the most sense, we don’t need more imported ethanol and Brazil isn’t exactly awash in ethanol,” [Matt] Hartwig said.
And “by removing the tariff you essentially would be asking the American taxpayers to subsidize the production of foreign ethanol, the tariff is an offset to the tax that refiners are paid for blending ethanol,” he said.
Hartwig does not explain how eliminating an import tariff (a tax on U.S. consumers) translates into subsidizing foreign ethanol production, nor does he address the economically appealing alternative of eliminating both the import tariff and the domestic tax credit.
A lot of attention has been given to first quarter oil company profits. But oil company stock prices are mostly unchanged relative to the S&P 500 in 2006. Meanwhile, the stock price of Archer Daniels Midland, the nation’s top ethanol producer, has increased from $24.66 per share on December 30, 2005, to $45.00 per share today–an 82% increase in just 131 days.
“Big Oil’s Best Defense Is Simple Economics”
So says Wall Street Journal columnist Alan Murray (subscription may be required). Murray credits new Exxon Mobil CEO Rex Tillerson’s defense of his stockholders when interviewed by Matt Lauer of NBC’s Today show. When asked by Lauer, “Would Exxon Mobil be willing to lower profits over the summer to help out in this time of need and crisis?” Tillerson replied, “Well, that’s not the business. We’re in the business to make money.” Murray says of Lauer:
You might think a network newsman earning $13 million a year would have a firmer grasp of capitalism. Would it really be a good idea for Exxon to take money from its shareholders — many of them pensioners — to subsidize fuel prices for sport-utility vehicle owners?* One of the beauties of the marketplace is that it eliminates the need for those sorts of distributional decisions, which no person — not even Matt Lauer — can make well.
Murray is more critical of politicians, including President Bush, House Speaker Denny Hastert, and Senate Majority Leader Bill Frist. Each of these leaders of the “party of business,” write Murray, “earns an ‘F’ for economic literacy.” Other politicians, most notably Sen. Arlen Specter (R-PA), have advanced legislation aimed at reducing concentration in the oil business. Murray criticizes them as well:
As for those who worry the merger of Exxon and Mobil might have created an industry that is too concentrated — well, stop worrying. Exxon Mobil still has only about 8% of the retail gasoline market in the U.S. And its size is a plus overseas, giving it the clout it needs to push for access to government-controlled oil reserves and the financial heft it needs to undertake multibillion investment projects. That’s all good for U.S. energy security.
Elsewhere in the May 10 Wall Street Journal, columnist Holman Jenkins comments on the same TV interview between Lauer and Tillerson:
Few are the subjects on which you can exhibit in public an abject, sub-protozoan stupidity without fear of damage to your reputation. Gasoline is surely a miracle commodity. Yet it should be bracing for politicians, the American people and the press that the only sensible opinion they’re hearing on $3 gasoline is coming from a reviled, overpaid energy executive, namely Exxon’s Rex Tillerson.
Jenkins says American’s “get the politicians they deserve”:
Politicians, in contrast, have made themselves conspicuous by rushing to propose “solutions” to $3 gas that are absurd if not deliberately conceived to cause harm. President Bush would force Americans to save gasoline by mandating higher fuel efficiency for auto makers, never mind that any American who cares to save money on gas already has plenty of high-mileage vehicles to choose from. But if Americans were entitled to choose comfort, convenience and safety over fuel economy when gas was $2, why not when gas is $3? Don’t ask, because there’s no sensible answer.
What Happened After Hurricane Katrina?
In Senate testimony last November, Federal Trade Commission Chairman Deborah Platt Majoras noted that after Hurricane Katrina, EPA waived summer gasoline requirements and low sulfur diesel requirements to overcome supply shortfalls. These waivers effectively terminated the summer fuel season and were effective nationwide.
Majoras cited EPA estimates that these requirements increased retail gasoline prices $0.03 to $0.11 per gallon (pp. 34-35). But these cost estimates at best applied to steady-state conditions, not the unusual situation of severe supply shortfalls such as accompany natural disasters or even to the normal springtime conversion.
Majoras also said “federal price gouging legislation would unnecessarily hurt consumers” and strongly advised Congress against enacting such a law:
The FTC is keenly aware of the importance to American consumers of free and open markets and intends faithfully to fulfill its obligation to search for and stop illegal conduct, which undermines the market’s consumer benefits. We caution, however, that a full understanding of pricing practices before and since Katrina may not lead to a conclusion that a federal prohibition on “price gouging” is appropriate. Consumers understandably are upset when they face dramatic price increases within very short periods of time, especially during a disaster. But price gouging laws that have the effect of controlling prices likely will do consumers more harm than good. Experience from the 1970s shows that price controls produced longer lines at the pump – and prolonged the gasoline crisis. While no consumer likes price increases, in fact, price increases lower demand and help make the shortage shorter-lived than it otherwise would have been.
Prices play a critical role in our economy: they signal producers to increase or decrease supply, and they also signal consumers to increase or decrease demand. In a period of shortage – particularly with a product, like gasoline, that can be sold in many markets around the world – higher prices create incentives for suppliers to send more product into the market, while also creating incentives for consumers to use less of the product. For instance, sharp increases in the price of gasoline can help curtail the panic buying and “topping off” practices that cause retailers to run out of gasoline. In addition, higher gasoline prices in the United States have resulted in the shipment of substantial additional supplies of European gasoline to the United States. If price gouging laws distort these natural market signals, markets may not function well and consumers will be worse off. Thus, under these circumstances, sound economic principles and jurisprudence suggest a seller’s independent decision to increase price is – and should be – outside the purview of the law.
To be sure, there may be situations in which sellers go beyond the necessary market-induced price increase. A seller who does not want to run out of a supply of gasoline to sell might misjudge the market and attempt to charge prices substantially higher than conditions warrant or than its competitors are charging. News stories of gasoline retailers panicking and setting prices of $6.00 per gallon are evidence of such misjudgments after the hurricanes. But the market – not price gouging laws – is the best cure for this. Temporary prices that are wildly out of line with competitors’ prices do not last when consumers quickly discover that other stations are charging lower prices. A single seller in a competitive market cannot unilaterally raise prices for long above the level justified by supply and demand factors. As long as they are not sustained by collusive activity, departures from competitive prices cannot endure for long in such a market. The few retailers who raised prices to the $6.00 level reduced them just as quickly when it became apparent that they had misjudged the market.
Even if Congress outlaws price gouging, the law likely would be difficult to enforce fairly. The difficulty for station managers, as well as for enforcers, is knowing when the managers have raised prices “too much,” as opposed to responding to reduced supply conditions. It can be very difficult to determine the extent to which any more moderate price increases are necessary. Examination of the federal gasoline price gouging legislation that has been introduced and of state price gouging statutes indicates that the offense of “price gouging” is difficult to define. For example, some bills define “gouging” as consisting of a 10 or 15 percent increase in average prices, while most leave the decision to the courts by defining gouging in nebulous terms such as “gross disparity” or “unconscionably excessive.” Some, but not all, make allowances for the extra costs that may be involved in providing product in a disaster area. Few, if any, of the proposed bills or state laws take account of market incentives for sellers to divert supply from their usual customers in order to supply the disaster area, or incentives for consumers to reduce their purchases as much as possible, minimizing the shortage. Ultimately, the inability to agree on when “price gouging” should be prohibited indicates the risks in developing and enforcing a federal statute that would be controversial and could be counterproductive to consumers’ best interest. (pp. 9-11, footnotes omitted)
Meanwhile, the FTC has not found evidence of price-gouging or price manipulation.
FTC studies indicate that higher retail prices are generally not caused by excess oil company profits. Although recent oil company profits may be high in absolute terms, industry profits have varied widely over time, as well as over industry segments and among firms.
EIA’s Financial Reporting System (“FRS”) tracks the financial performance of the 28 major energy producers currently operating in the United States. Between 1973 and 2003, the annual average return on equity for FRS energy companies was 12.6 percent, while it was 13.1 percent for the Standard & Poor’s Industrials.46 The rates of return on equity for FRS companies have varied widely over the years, ranging from as low as 1.1 percent to as high as 21.1 percent during the period from 1974 to 2003.47 Returns on equity vary across firms as well.
High absolute profits do not contradict numbers showing that oil companies may at times earn less (as a percentage of capital or equity) than other industrial firms. This simply reflects the large amount of capital necessary to find, refine, and distribute petroleum products.
The FTC’s analysis has not been cited by any Member of Congress in remarks about the current gasoline crisis.
The Biomass Alternative
John Deutch, professor of chemistry at MIT and former undersecretary of energy in the Carter administration and CIA director in the Clinton administration, has published an essay on biomass as a substitute for gasoline in the May 10 Wall Street Journal (subscription may be required). The essay welcomes President Bush’s call for the U.S. “to move beyond a petroleum-based economy” but says public policy “is driven by farm-state politics”–in other words, subsidies for corn-based ethanol. (Section 208 of the Energy Policy Act of 2005 extends these subsidies to ethanol made from cane sugar.)
Deutch is skeptical about ethanol because of the amount of fossil-fuel energy that is required to grow, fertilize and harvest corn, then process ferment it into ethanol and ship it to market. According to Deutch:
Politicians from corn-states and other proponents of renewable energy support this federal subsidy, but most energy experts believe using corn to make ethanol is not effective in the long run because the net amount of oil saved by gasohol use is minimal.
Deutch believes that “it takes two-thirds of a gallon of oil to make a gallon equivalent of ethanol from corn. Thus one gallon of ethanol used in gasohol displaces perhaps one-third of a gallon of oil or less.” That means the 10 cent per gallon tax credit on gasohol “costs the taxpayer a hefty $120 per barrel of oil displaced cost. Surely it is worthwhile to look for cheaper ways to eliminate oil.” Deutch does not delve into the cost implications of the other ethanol subsidies.
Deutch argues that “cellulosic biomass” (that is, agricultural residues from food crops, wood and crops such as switch grass) offer a better alternative provided that biotechnology can be harnessed to develop the enzymes necessary to digest them. “This approach merits genuine enthusiasm,” though it is unclear whether he is speaking as an intellectually challenged chemist.
Deutch is undeterred by the prospect of converting 25 million acres of farmland into biomass production, which he says would be necessary to displace 1-2 million barrels of oil per day. Missing entirely from Deutch’s analysis is any consideration of the environmental costs of committing this much land to energy production. By comparison, the Arctic National Wildlife Refuge is 19 million acres. Only the 1.5 million acre “1002 Area” has been proposed for exploration, with development predicted to use less than 2,000 acres. The U.S. Geologic Survey reported in 1998 that this field contains 7,668 million barrels (95% confidence intervals = 4,254 and 11,799 million barrels, respectively. How much of this oil is recoverable depends on market prices. According to Figure 6 in the USGS assessment, more than 6 billion barrels (95% confidence intervals = 2.5 and 10 billion barrels) are recoverable at a cost of about $25 per barrel
Significant improvements in recovery technology are required to extract the rest of the reserve, but sustained high world prices provide the strongest incentive for such innovation. Also, several billion barrels of known reserves are not accounted for in the USGS estimate of the 1002 Area reserve, nor is the possibility that advanced methods could be used to extract oil from outside the 1002 Area without disturbing it.
What You Can Do to Save the Planet
A bit of humor after a busy day of blogging.
14.27 cents × (1 liter/0.264 gallon) = 54.05 cents per gallon.
* Murray incorrectly implies that if Exxon alone lowered the price it charges distributors and franchisees, that retail gasoline prices would decline. Exxon supplies a small fraction of the gasoline market. The only way for Exxon’s action to be effective would be for it to illegally collude with other oil companies.