Thursday, April 27, 2006

Or Higher?

Tuesday's posting focused on the oil supply and inventory influence on gasoline prices. I concluded that the inventory picture suggests lower prices ahead, but that risk-driven speculation could prevent that or keep prices going higher. An opinion piece in today's Financial Times describes the laundry list of energy proposals floating around Washington in unflattering terms. The Congress and state legislatures must be seen to be addressing the problem in the lead-up to the off-term election in November, but most of their current proposals are mere window-dressing, designed to mollify the public by punishing oil companies and investors.

Even the most supply-oriented ideas are looking in the wrong direction, if the goal is to moderate gasoline prices anytime soon. Producing more crude oil from the US--or more accurately slowing the steady decline in US production--by tapping the Arctic National Wildlife Refuge and putting more acreage in the Gulf Coast and other offshore waters in play will help, but not many for years. This does nothing to address our growing shortage of refining capacity. I wrote at length on this topic after Katrina, and nothing substantive has changed. While the main factor determining the level of domestic oil production is geology, over which we have no control, becoming dependent on foreign refineries has been entirely a matter of choice, the direct outgrowth of environmental and permitting restrictions that have been placed on the industry over the last several decades.

Consider the consequences for gasoline prices. During the 1990s, sufficient domestic refining capacity existed to cover our needs most of the time, and US gasoline imports were modest, averaging under 400,000 barrels per day. The average price differential between unleaded gasoline futures and West Texas Intermediate crude oil for that decade was $4.76/bbl. So far this year, gasoline imports are running over a million barrels per day, and the margin between gasoline and crude is at about $16.00/bbl, averaging $8.00 over the last six months . If more refineries had been allowed to expand and new refineries been constructed, we could be paying as much as 35 cents less for gasoline, now. Even recognizing that other factors, such as the balkanization of gasoline specifications and the switch from MTBE to ethanol have complicated the supply & distribution systems of the oil companies, we could have had gasoline at $2.60-2.70/gallon, despite crude oil at $75/barrel.

However, it takes years to design and build a new refinery, especially here, so our available responses to the current high refining margins are limited. As it happens, the only liquid fuel facilities that can be built quickly enough to make a difference are ethanol plants, because they are so much smaller, individually, and face little or no local opposition. Still, it takes an awful lot of ethanol plants to make up for the lack of a single oil refinery, considering that the entire US ethanol output is roughly the gasoline yield of New Jersey's four refineries.

Ironically, circumstances have produced precisely the result that so many have advocated for years: gasoline prices high enough to stimulate conservation. As the FT points out, either high gas prices are good or they are bad, whether they result from OPEC collusion, restrictions on refinery construction, or elevated gas taxes. If they are good only when they result from taxes, but bad when they benefit oil companies and their shareholders, then the current histrionics are revealed as an exercise in populism, rather than the beginnings of a sensible energy policy.

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