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Mon May 19 23:06:50 2008
More Bad Gas
Congress and the President pass a bad law.

Fill 'er up!
Image courtesy of Walter Siegmund (wiki)

Today President Bush signed into law a dubious bill submitted by the US Congress. It was another attempt to reduce oil prices, and it may have serious consequences. (See High Oil and Gas Prices for another even less effective Congressional attempt).

Senators had noticed that the US Strategic Petroleum Reserves were buying 70 thousand barrels of oil a day. Their thinking was that stopping these purchases would help reduce demand and therefore prices.

Don't get me wrong, I hate high gas prices. I just filled my tank today and I was stunned (prices here are now well over $4 per gallon). I'd like prices to come down.

However, the Congressional bill was ill-advised for two reasons:

First, the strategic reserve purchases are a miniscule part of total demand. The United States consumes over 20 million barrels of oil a day. The 70 thousand barrels amounts to 0.3% of total US demand. Not 3%, 0.3%. Furthermore, oil is a global commodity, so the impact has to be judged relative to global consumption. The world consumes over 80 million barrels of oil a day.

So the US Congress has removed less than 0.1% of global demand for oil. It is unlikely that the global markets will even notice that tiny drop in demand. But let's say the markets do notice, and the price drops by 0.3% (I've generously multiplied the demand drop by 3 since oil is after all an inelastic supply).

In the best, most generous case, Congress may have reduced gas prices by one penny. Hey, maybe that's worth it, right?

Wrong. That brings me to my

Second reason that the Congressional bill was ill-advised: Congress is assuming that we are in a temporary period of high oil prices. Halting strategic purchases would help ameliorate the high prices, and then the purchases can resume when prices come down a bit. (The bill--now a law--stipulates that purchases can resume again at the end of 2008).

However, there is a very good chance that prices will keep rising for the foreseeable future. Why would prices drop, after all? Demand won't drop very quickly, since a demand drop will require that large numbers of American consumers and industries replace their inefficient cars and factories with more efficient models, which will take a long time. (Based on the 1970's oil shock, it takes several years for demand to come down).

But even if US demand is dropping, other world demand (China, India, others) continues to accelerate. A drop in US demand would help a lot, but this isn't the 1970's anymore. There are a lot more industrialized countries to buy that oil.

And oil production is peaking. Russian oil production peaked in 2007, leaving only OPEC countries to keep up with production. However, only Saudi Arabia has significant reserves, and they are running out of easy-to-extract oil.

Oil industry observers know all this. They expect prices to rise, not decline. Goldman Sachs recently predicted that oil prices would reach over $140 per barrel in 2008, up from close to $130 today. And they predict prices in the $150-200 range in the longer-term (6 months to 2 years). That would mean gas prices well over $6 per gallon.

So what did Congress actually accomplish? We've saved a penny per gallon now (maybe), and then the strategic reserve will have to start buying again later when gas is even more expensive. And if you believe that stopping the purchases helped prices now, then you have to agree that starting the purchases later will hurt prices then.

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