Republican's Ace in the Hole

Written by Aaron M. Rodriguez

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With gas prices topping $4 a gallon, a productive U.S. energy policy has moved to the center stage. According to a CNN poll conducted last month, 48% of Americans consider gas prices “an extremely important” issue. And another CNN poll, conducted by Opinion Research Corp. a few weeks ago, indicates 72% support drilling on the Californian and Floridian coasts.

Barack Obama’s plan to address soaring gas prices essentially involves investments in energy technology research, renewable energy, and in energy efficient vehicles. Like most investments, however, they will not yield returns immediately. Working families burdened at the pump will wait 10-30 years before returns are available.

Understanding this predicament, House Speaker Nancy Pelosi and congressional democrats are beginning to feel the squeeze of the current energy crisis. Pelosi has called on President Bush to release oil from the strategic petroleum reserve to offset escalating costs at the pump. However, the White House has officially stated that our strategic reserve is not intended to address arduous gas prices via market manipulation, but to provide an emergency supply of oil when major disruptions are felt in our domestic lode.

When hurricanes Katrina and Rita struck the gulf of Mexico in 2005, it severely damaged 150 oil rigs, sunk 36 of them, and dropped oil production by 95%. Two weeks later, 60% of our daily oil production was offline. As a result, it caused a major upsurge in gas prices. Since the gulf represents 25% of our nation’s oil production and 16% of our refining capacity, any major disruptions in that region is likely to retard production and reduce the availability of supply. Soaring prices, due to natural disasters, make a salient point for the Republican Party that federal bans on drilling in the Pacific, Atlantic, and the eastern Gulf regions have limited our ability to absorb major disruptions without suffering substantial setbacks. If we had an energy policy that diversified oil production in the U.S., no single weather pattern would hike up gas prices.

 

In April of 2006, Pelosi blamed a republican-controlled congress for skyrocketing gas prices. She said:

With skyrocketing gas prices, it is clear that the American people can no longer afford the Republican Rubber Stamp Congress and its failure to stand up to Republican big oil and gas company cronies. Americans this week are paying $2.91 a gallon on average for regular gasoline – 33 cents higher than last month, and double the price than when President Bush first came to office. With record gas prices, record CEO pay packages, and record oil company profits, Speaker Hastert and the Majority Congress continue to give the American people empty rhetoric rather than join Democrats who are working to lower gas prices now. Democrats have a commonsense plan to help bring down skyrocketing gas prices by cracking down on price gouging, rolling back the billions of dollars in taxpayer subsidies, tax breaks and royalty relief given to big oil and gas companies, and increasing production of alternative fuels.

At the time, gas prices were at $2.91 a gallon. Pelosi found herself in a good position to showcase her party. After all, in just 6 years, gas prices increased by 41% under GOP control. Certainly the Democrats could do a little better than that, right? Since the Democrats assumed control in 2006, it took just 18 months for gas prices to increase by 95%. In other words, gas prices doubled at four times the rate. Where is Pelosi's "commonsense plan" to thwart record-breaking prices at the pump? Why didn't the Democrats stand up to Big Oil for working class families?

One way to deflect criticism is to find a good scapegoat. In a congressional session, Big Oil executives were compelled to answer for their record high profits and to justify their government subsidies. They were accused for making profits at the expense of the consumer although leading pharmaceutical and software companies were given a pass. At one point, Illinois Senator Richard Durbin asked, "Does it trouble any one of you - the costs you're imposing on families, on small businesses, on truckers?" Oil Executives were quick to say that high prices were linked to our failure to increase supplies, renewable energy, and conservation here at home. And they were right.

By the conclusion of the hearing, we learned that government gains more from the sale of oil than major oil producers. Big Oil makes approximately 6 to 8 cents per gallon of gasoline. Big Government, on the other hand, makes about 59 cents per gallon of gasoline through a variety of different taxes. If one does the math, the tax revenue is roughly 8 times the profit margin of oil companies.

After a botched attempt to scapegoat Big Oil, congress took a crack at the oil speculators. Unlike the earlier charade, suggesting that speculators are the cause of high gas prices actually has some traction. Speculation in future markets can certainly increase prices by manipulating supply and demand. But how do we know this is the cause of our current situation?

ImageA good way to do this is to examine the relationship between inventories and prices. For instance, if a farmer believes that corn will become more valuable in the near future, there is an incentive to maintain a larger inventory. By doing this, the farmer waits to sell for a higher price. When farmers stockpile their product, it limits the availability of corn to the market, which subsequently increases the demand. The result is an increased price that corresponds to an increased inventory. Eventually, farmers will run out of space to store corn. When this happens, they will have to make their supplies available to the market. If prices decrease as the inventories decrease, it would strongly suggest that market speculation is the principle cause. However, if the inventories decrease and prices remain the same or even increase, then we ought to look somewhere else.

ImageEarly in 2008, American petroleum inventories were at a record high of 347 million barrels, but in the summer of 2008, these inventories dipped below 300 million barrels. During this time, gas prices continued to soar into record highs. If today’s gas prices were the result of a speculation bubble, it would have popped when the inventories decreased in the summer, but it didn’t. Market speculation is not the problem. Instead, today’s problem is a result of a stagnant supply and increasing demand. This year alone, gasoline consumption of China, Russia, India, and the Middle East will increase by 4.4%, which for the first time will surpass the U.S. Since 1990, China has been increasing its consumption of oil at an average rate of 6% to 7% a year, and they are on pace to exceed the U.S. in less than 20 years. India isn’t doing too shabby either. Their economy is growing at 8% a year. Car sales are up 30% despite fuels costs, and they will soon be the 4th largest consumer of oil after the United States, China, and Japan. By all indications, global demand is increasing whereas the global supply is relatively static.

If oil demand were steadily increasing, why would OPEC nations like Saudi Arabia increase production? Well, an interesting thing happened. In May of 2008, the Saudis snubbed Bush when he requested they increase oil production. A month later, however, they decided to reverse their decision. Why? One good reason is that political dispositions in the U.S. have changed toward drilling. Senator McCain, for instance, has modified his position on offshore drilling, and President Bush lifted the Presidential ban originally set by his father. Polls indicate that almost 75% of the American people support the idea. With the future market expecting to receive an increase in supply, it would be fiscally imprudent for oil producers like Saudi Arabia to sit on large deposits of oil when its current value is so high. If a new supply is introduced, the demand will fall. However, if they increase production now, they will get the most bang for their buck. There is a strong incentive to sell.

The Republican Party has the right idea about drilling offshore. Although drilling and refining takes years yield marketable oil, the anticipation of those offshore barrels will displace barrels ready for today’s market. Pelosi has no plans to lift bans for drilling offshore (see map below) despite wide support from her constituency. The Democrat Party isn’t necessarily on the wrong side of the energy issue, but while they refuse to respond to the demands of the free market, we will continue to pay for it.


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