Why Gas Is Cheap (Hint: It’s Bad News)

Some of my olde– uh… more experienced readers may remember when gasoline first topped one dollar a gallon at the pumps.  If you’re finding it tough to put a date to the event, here’s some hints:  Jimmy Carter was President, there were hostages in Iran (which was about to be at war with Iraq), and America was in the grip of an energy crisis.

Today, the price of gas is again dropping toward the 1980 peak of $1.40 per gallon.  Considering inflation, and adding in all the instability in the Middle East — ISIL, the Saudi-Iran tensions, et cetera — calling this price trend counterintuitive is an understatement.  After all, several decades ago we were informed that the world’s oil supply would have run out by now, and yet now we hear that production is greater than it has ever been.  So why the apparent paradox?

What Comprises The Price

In order to look at the causes and ramifications, we must first understand what it is that actually drives the price of the gasoline you buy at the pump.

Of the approximately 20 million barrels per day of crude oil consumed in the United States, just under half is converted to gasoline.  The majority of this is used to propel American consumers a total of half a million miles; much of which is the normal work commute.  In a very real sense, then, this production goes to something that most of us wouldn’t consider a luxury, or indeed even an optional expense.

According to the US Energy Information Administration (which is where a lot of my data comes from), nearly half the cost of at-the-pump gasoline is driven by the price of crude oil.  When that fluctuates, pump prices rise and drop accordingly.  Around a quarter goes to taxes (a large percentage of which go back to the oil companies as subsidies), about 20% is spent on refining, and another substantial fraction goes into distribution and marketing.  Oddly, the local gas station owner profits very little on sales — often around 1-2% of the final price.

Generally, while price can fluctuate widely, the taxes, transportation, and refinery costs remain fairly consistent.  Where the Federal government’s resistance to new pipeline construction (whether justified or not) may well be said to vastly increase transport costs, the actual price difference from such factors at the pump is minimal — a few cents per gallon, perhaps a dime.  Gasoline refining is a mature technology, developed a century ago and still using many of the same general methods, modern developments in zeolites notwithstanding.

So from all this we can safely conclude that the current low gas prices are due entirely to the drop in the market price of crude oil.

[A note on oil subsidies:  Most of these are in the form of tax exemptions for expenses.  The cost of oil exploration and the expense associated with developing new oil fields, for example, is tax-deductible, and it probably should be; it’s a legitimate cost of business, after all.  But it’s usually counted as a part of the “subsidies” total.  There are other benefits, mainly in tax breaks, that are less obviously legitimate, but it takes a close examination of the actual numbers for one to understand exactly what’s going on.  It’s not simple.]

Why Is Crude So Cheap?

Oil is a limited commodity; fossil fuels generate slowly over geologic time periods measured in epochs, and it stands to reason that there’s only just so much of it available.  As technology advances, however, previously inaccessible reserves in oil shale and tight geologic formations have become available, and development due to this, especially in the United States and Canada, has recently spiked.

Geopolitical instability has greatly reduced production in several of the oil-rich nations of the Middle East and northern Africa.  Iraq and Syria are in the grip of insurgencies; Yemen and Libya remain unstable; Iran is becoming increasingly militant.  Venezuela, in South America, sits atop the largest crude oil reserve in the world, but has been in the grip of recession and extreme unrest for the past three years.  And yet despite all this, global production remains extremely high.

The reason for this is simple:  Saudi Arabia, the world’s largest oil producer, is pumping at record levels.  They are doing this, presumably, to drive the price down as far as they can in order to discourage competition — particularly from the new American and Canadian oil companies, several of which are facing serious financial troubles, even bankruptcy, as a direct result of the ongoing price situation.

At the same time, American and Canadian producers are unable to restrict their production, and such countries as Venezuela simply cannot afford to.

But Why Is This Bad News?

There are three major locations in the world where the massive oil overproduction is responsible for severe instability both in terms of local and national economies and in popular unrest, even uprisings.

Venezuela:  For decades, Venezuela’s main industry has been oil.  As a result, manufacturing in other areas has almost vanished, and even agriculture has diminished to a point where the country has become a net importer of food.  The present conditions force continued massive oil production even in an environment of miniscule prices because so very much of the national wealth is tied up in this one industry.  Food supplies, as well as those of staples ranging from toilet paper to medicine, are increasingly unavailable, and domestic unrest is on the rise.

The United States and Canada:  When overseas overproduction first became a serious problem a couple of years ago, most North American companies responded by the simple expedient of halting new exploration and drilling operations.  Extant wells, however, have remained so very productive that domestic supply has scarcely diminished — and halting the production of an established well can lead to its effective destruction as a resource.

The Middle East:  Since ISIL has long funded their operations through oil sales, the artificial price decrease has led to rapidly declining conditions within their sectors of control — a good thing for us.  However, low prices are also harming the economies of such nations as Iran and Yemen, drawing threats and even attacks against the Saudis, and even the recovery of Iraq after its conquest has been slowed drastically by the poor global oil market.

Even Saudi Arabia cannot truly be said to be benefiting from this vast oversupply of oil.  With prices so vastly diminished, profits have plummeted disproportionately, and Saudi Arabia’s economy is strongly dependent on oil exports.  They do, however, have vast reserves of material wealth, and so long as the global economy remains somewhat stable — fairly likely in this period of artificially cheap energy — their own nation should suffer none of the shortages plaguing Venezuela or the unrest bedeviling their near neighbors.

What Does This Mean For Us?

For right now, this means that North American oil companies are a bad investment.  Short-term, industries that promote alternative energy, including the corrupt and heavily subsidized ethanol-from-corn process that keeps Iowa in business, will also suffer; likewise, alternative energy technologies research will take a hit.  Housing markets will gain somewhat as commuters opt to live that little bit further from their jobs, and fuel-inefficient vehicles such as SUVs and minivans will continue to enjoy boom sales numbers — for a short while.

But no nation has an independent economy, and increasing unrest in Venezuela and throughout the Middle East is likely to have severe, lasting, and above all unpredictable repercussions throughout the world.  If the present situation continues for an extended period, global economic chaos is likely — which alone tells us that the situation cannot continue indefinitely.  In a very short time, Saudi Arabia will be forced to reverse its policies in order to ensure global economic stability, and gas prices will rise again soon after.

In the mean while, North American oil companies are about to start selling cheap as they go through popcorn bankruptcy.  Since the Saudis have both the money and the interest, we can expect vast overseas purchases of our domestic development.  While absolute control of production is going to be limited (some of the oil fields are leased), this will nevertheless end up with increasing foreign influence on the market in the future.  This will remove much of our domestic price control.

As oil prices continue to rise, alternative energy will again become fashionable.  Power generation and the electric car will both have spikes in demand and profitability in the moderate future; with the decreased demand for commuter gasoline combined with the commensurate increase in grid-power consumption, production and transmission utilities will see a major boom, as will new advances such as Tesla power and recharge stations.

The immediate housing boom will become, inevitably, another bubble; in five to seven years, the demand for distant commuter housing will dip sharply and new homebuyers will find themselves underwater on their mortgages.  Demand for housing more local to the workplace will continue to rise, however, so no general and widespread crisis is likely — although real estate will become a buyer’s market for some time afterward.

The Bottom Line

What’s happening is evident; the consequences are known and largely undesirable.

As a nation, we have some options to decrease the negative impact of the upcoming chaos.  One method would be to impose an immediate proactive tax on gasoline at the pump, revenue from which would be devoted to establishing support infrastructure for electric commuter cars as well as increasing tax advantages for their purchase.  Alternately, protective import tariffs could be levied on foreign oil; this, combined with an aggressive diplomatic intervention in tottering Venezuela, could easily create a global stability in the markets that would ameliorate chaotic outcomes while simultaneously diminishing Saudi influence.

Either of these two options is unlikely.

While there are several telling geopolitical reasons that militate against any protective tariff at present, that’s not the main reason.  Supporting any tax  which increases the price of gas at the pumps is political suicide in an election year, and this is one of the biggest election years in modern times.  Congress would find it tough to pass such a measure without a bipartisan mandate — and that’s highly unlikely at present on any issue whatsoever.  The leadership of both parties would unite in their vehement opposition to anything bipartisan; while I hesitate to levy blame, present conditions in the Presidential race indicate that establishment Democrats would be the major obstacle.  (To be fair, at another time it would be the Republicans.)

So the bottom line is that, as usual, nothing will be done.

Addendum 16Feb16:

This just in:  There has been an international deal publicly (though, as I understand it, not yet formally) announced between the Russians and the Saudis to fix oil production at its present rate.  Ostensibly intended as a matter of anti-ISIL policy, this agreement doesn’t so much fix production (which has already been done) as it does fix end conditions for the present arrangement — conditions which we can presume will not be in the best interest of North American (or Venezuelan) oil production.

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