Thursday, June 21, 2007

In the Meantime

For all the discussion on Capitol Hill about energy legislation--the subject of my last two postings--I have yet to hear a disclaimer that the impact of these proceedings on actual energy supply, demand, or prices in the next five years will be minimal. And yet, when you consider the time lags associated with the activities covered by these policies, whether relating to the expansion of alternative energy production, improvements in fuel economy, or even the easing of some restrictions on offshore oil and gas drilling, that must be true. It's not obvious that the public has figured that out, yet, but if they are expecting help from Congress at the gas pump any time soon, they are probably going to be disappointed. Unless they are warned in advance, that could have political consequences.

Consider the proposed new fuel economy standards. The bill by Senators Feinstein and Durbin, the "Ten-in-Ten Fuel Economy Act", would increase the CAFE standard for new cars to 35 mpg by 2020 and close the "SUV loophole" treating SUVs differently from passenger cars by 2013. The bill doesn't prescribe how this target would be phased in, but even if new car fuel economy were increased by 1 mpg/year starting next year, by 2012 the total improvement in the entire US car fleet of 243 million vehicles would only be about 3%. That's the equivalent of roughly 300,000 barrels per day (bpd) out of a gasoline market that exceeds 9.3 million bpd.

Now add in the biofuel mandates in Senator Dorgan's bill, S-875, the "SAFE Energy Act of 2007." Looking at its effect between now and 2012, we see the quantity of ethanol in the gasoline pool increasing from 4.7 billion gallons to 13.2 billion gallons per year. Ignoring concerns about the potential impact on food prices, and after adjusting for ethanol's lower energy content, that incremental supply works out to just under 400,000 bpd, or about 4% of current consumption.

Together, these two measures, which appear to offer the largest near-term fuel price impact of any of the provisions under consideration, would displace about 7% of our current gasoline consumption within five years, through a combination of efficiency gains and alternative supply. If everything else stood still, that would almost certainly be enough to exert significant downward pressure on gasoline prices--barring any new taxes that might be imposed in the interim. But how likely is it that everything will stand still? The recent price spike only slowed gasoline demand growth to about 1% per year. That means that over five years, the underlying growth in the car population and in total miles driven could erode all but 1-2% of the benefit of the new energy policies. That would reduce the impact on fuel prices to a level indistinguishable from the background noise.

That doesn't mean that changes in energy policy are unnecessary or futile. After all, most of the measures under discussion are designed to have their biggest effect after 2017. What it does mean, though, is that for at least the next few years gasoline prices will continue to be influenced primarily by the same things that have affected them in the past. That's why factors such as the expansion of US refinery capacity and the diversity of our sources of crude oil and refined product imports remain highly relevant, even as our efforts to reduce their importance in the future make these issues much more complicated. Rather than creating high expectations that can't be met in the near term, we ought to acknowledge the complexity and potential volatility of the transition period ahead.

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