Thursday, February 12, 2009

The Other Stimulus

A short item on gasoline prices in today's Wall Street Journal had me scratching my head this morning. It suggested that the recent modest recovery of gasoline prices has essentially ended the economic stimulus that cheaper gas has provided to the economy. The article's author, Mark Gongloff, has covered energy for some time. He ran the Journal's "Energy Blog", before it morphed into the current "Environmental Capital" blog, and he did it well and with insight. However, in this case, he's off by a country mile, because the stimulative effect of gas prices doesn't depend on their continuing to drop, but rather on the comparison with prices last year. Moreover, when average pump prices bottomed out at $1.61 per gallon a few weeks ago, wholesale gasoline futures were cheaper than crude oil. That wasn't sustainable, and we're now seeing the correction. The real end of the cheap gas stimulus is probably at least a year or two off, when the resumption of economic growth sends demand higher, just as global oil supplies start shrinking due to the accumulation of unchecked decline rates.

Although at this week's national average for unleaded regular of $1.93 per gallon, gasoline is up by a quarter a gallon since the first week of January, it is still a buck cheaper than this time last year--when it was just beginning a run-up that peaked at $4.11 after the Fourth of July. That translates to a current year-on-year savings of $40 per month for the average motorist--about equal to the "Making Work Pay" tax credit that most Americans will receive as part of the stimulus package. And unless gas prices spike much higher in the weeks ahead, the scale of the savings vs. the prior year should keep growing throughout the first half of 2009. We all know this can't last, but it's been a nice bridge, while we waited for Congress and the new administration to decide how to take on the recession.

The reasons why the stimulus from cheap gas won't endure are starting to pile up. Although demand has fallen faster than OPEC can cut current output, resulting in a big accumulation of oil in storage tanks and oil tankers, OPEC has announced that it would delay 35 new oil projects. We've also seen a few major oil companies and many large independents cut their capital programs--some because the projects don't make economic sense at $40 per barrel, and others simply because their cash flow is down and they can't borrow easily in today's market. At the same time, the new US Secretary of the Interior has announced a six-month delay in plans to allow drilling in previously-banned areas of the Outer Continental Shelf. All of this will have a delayed effect on production, because of the time involved in planning and executing big oil projects. We might even see output grow for another year or two, thanks to the lagged effect of projects that were initiated when oil prices were on the way up. But fairly soon reduced drilling will be unable to hold back the steady depletion of existing reservoirs, and an underlying decline rate estimated at least 4.5% per year will assert control. At a current global production rate of 85 million barrels per day (MBD), that's nearly 4 MBD per year of new oil production that must come on every year, just to maintain present capacity, and it won't happen if drilling falls off a cliff.

Meanwhile, the benefits of cheap gas should last at least long enough for the economic effects of the stimulus bill to kick in. I'll take a closer look at those, once I get the text of the version that came out of the House/Senate conference committee and should be voted on in the next few days.

No comments: