Newt Gingrich seemed to be shooting from the hip when he promised, if elected, to bring us gasoline at $2.50 a gallon. Yet cheaper gas is not out of question once the price of crude oil is brought down to about $60 a barrel. And I readily agree with Gingrichs policy prescriptionsprimarily among them increasing domestic production of oil. But it may also take conservation (or substitution ) to cut, by 40%, the world price of the raw material for motor fuels. As gas prices rise to $5 during the summer driving season, Obama is feeling the heat but has not produced new ideas. On the contrary; all his policies tend to make gas more costlyopening the door for GOP initiatives.
We have to be on guard, however, against populists who claim we could have one-dollar gas if not for speculators, world-government-Trilateralists, and Big-Oil conspiracies. They make rational discourse difficult and devalue valid criticism of current White-House policies.
From crude to the pump
Lets start by parsing this gas price of $2.50which really requires $1.50/gal crude oil. But at 42 gallons in every barrel, we already passed that threshold. The world price of crude, now at $106 a barrel, is likely to rise further as the dollar falls, and as demand increases and low-cost oil fields become depletedin spite of likely advances in extraction technology.
Of course, to the basic cost of crude one has to add the costs of refining, transportation, and distribution, which make for approximately 50 cents per gallon. Among the factors increasing the price of gas at the pump are complex EPA mandates that require up to 18 boutique formulations for gasoline, which depend on the region and time of year; they also complicate the logistical problems tremendously and can lead to local shortages.
Then there are federal and state taxes, which are now averaging about 50 cents a gallon: 18.4 cents for the federal tax, plus state taxes that vary greatly from state to state. In truth, gas taxes, advertised as highway user fees, also serve as consumption taxesin many ways better than the much-debated value-added tax (VAT). Note that gas taxes do not use up resourcesunlike refining and distribution, which are resource-intensive but essential. By contrast, additives like ethanol not only consume large amounts of energy, but also constitute essentially a waste of resources.
Gas tax revenues go into the Highway Trust Fund, to be used to repair highways and bridgesbut they are often also spent on political pet projects. They may have been adequate at one time, but they are no longer so; gas taxes are not indexed to the price of crude oil or to inflation, and increased use of electric cars and hybrids reduces revenues further. President Reagan doubled the federal tax, but we may need to raise it furthera third rail that politicians do not want to touch. One alternative is to pay for transportation infrastructure from general treasury fundswhich means from all taxpayers. Another method is to expand greatly existing road mileage charges, highway and bridge tolls.
Another factor raising the cost of transportation is the congressional mandate for adding ethanol, which has not yet been canceled. It is doubtful even whether modern cars with electronic fuel injection need an additive like ethanol, which also reduces car mileage (since it has only 61% of the energy content of gasoline)thereby adds a hidden cost to posted price at the pumpdoes not cut CO2 emissions, and has sharply raised food prices globally. As much as 40% of the U.S. corn crop now goes into ethanol productionand the Obama White House wants to raise the mandate from 10% to 15%!
Further, the EPAs 2012 Renewable Fuel Standard (RFS) causes refineries to pay millions of dollars for cellulosic ethanol waiverswith the cost passed on to motorists. But there is no commercial production of cellulosic biofuels. The American Petroleum Institute has sued the EPA over such unachievable use requirements, filing a petition for review on March 12 in the U.S. Appeals Court for the District of Columbia. EPAs standard is divorced from reality and forces refiners to purchase credits for cellulosic fuels that do not exist, said API.
World price of crude oil: Supply and demand
But the major factor in gas prices is still the price of crude oil on the world market, set by supply and demandwith supply controlled by the OPEC cartel. More than half of our trade deficit$330 billion out of $560 billionis used to buy imported crude. While increasing U.S. production does increase security and improve dollar outflow and trade balances, it may have little effect on the world oil situation. We are talking about relatively minor increases in U.S. oil production compared to a global supply of nearly 90 million barrels per day. By the time our production ramps up to a higher value, global demand will have increased, particularly in East and South Asia.
Also, as pointed out recently in the Wall Street Journal by former National Security Council director Robert McFarlane, the OPEC cartel, and especially its Saudi Arab core, can always reduce oil production to achieve a world price that would maximize its profit stream over the long run.
By the same token, release of oil from the U.S. Strategic Petroleum Reserve, an election-year maneuver under consideration by the increasingly desperate White House, would accomplish little. It might produce a temporary dip in the world price of crudefor the benefit of all oil consumers, including our commercial competitors in China and elsewhere. But again, it can be easily offset by Saudi Arabia if the Saudis so choose.
There is, however, a scenario that could reduce the world price and lower gas prices at the pump. In modeling the optimum price path for world oil (i.e., one that would maximize the profit stream for Saudi Arabia), I found that the most sensitive parameter is discount ratenot its normal value, but the one viewed by Saudi decision-makers. Put more colloquially, if Saudis fear loss of control over oil revenues in the near future (for a variety of political reasons), they will be tempted to increase their production to a maximum (even though it would lower the world price)in order to maximize immediate profits.
It is important to stress that oil conservation can achieve similar results as increasing production; either method will reduce oil imports, with attendant benefits. One especially promising method of oil conservation is substitutionusing our plentiful supply of natural gas. With present prices around $2.30 per mcf (1,000 cubic feet), natural gas has only about 15% of the energy (BTU) cost of oila huge differential. And in fact, we are already seeing increasing efforts to transform trucks, buses, and other heavy-duty vehicles from oil to natural gasin the form of compressed natural gas (CNG), or even as liquefied natural gas (LNG).
The use of natural gas is particularly attractive when fuel is a major fraction of the cost of operation, and thus has a direct influence on profitability. Conceivably, even long-distance aircraft might benefit from the use of CNG or LNG, if the technical and safety problems can be solved. Finally, gas-to-liquid (GTL) conversion looms on the horizon; methanol is often mentioned. Several chemical processes are available, and pilot plants existbut so far there has been no investment in large-scale production.
The politics of gas prices
Politicians may not believe that low gasoline prices are technically and economically feasibleand some may not actually want thembut that is what almost all will promise voters. The Obama administration has shown little interest in lowering gas prices. In congressional testimony, Energy Secretary Steve Chu said his department is working to lower energy prices in the long term. But is the overall goal to get our price of gasoline down? asked Rep. Alan Nunnelee (R-Miss.). No, the overall goal is to decrease our dependency on oil, to build and strengthen our economy, Chu replied. No wonder that the latest Washington Post-ABC poll shows that nearly two-thirds of Americans disapprove of the way the president is handling the situation at the pump, where rising prices have already hit low-income groups hard.
Even traditional Democrat supporters, like labor unions (but not the powerful public-sector unions), are raising their voices as they see shovel-ready jobs disappearingthanks to Obamas veto of the Keystone XL pipeline. It has also been noted that most of the increases in oil and gas production have been on private land, not on federal leases. It is all part of the White House general opposition to fossil fuels, expressed so well by Obama during his 2008 campaign: promises to bankrupt the coal industry and to make electricity prices skyrocket. And all of this seems to be driven by a pathological fear of imagined climate catastrophes.
As we approach the presidential election of November 2012, we will be hearing much more about rising gas prices and the cost of energy generally. These circumstances will present an important opportunity for the GOP candidate to challenge Obamas performance and talk about the essential steps to rationalize the domestic oil market.