American Elephants

NEWSFLASH: Obama Doesn’t Understand the Laws of Supply and Demand. by The Elephant's Child
April 28, 2011, 7:41 pm
Filed under: Capitalism, Economy, Energy, Junk Science | Tags: , , ,

If President Barack Obama were to schedule a major speech tomorrow, and tell the assorted networks  that America was returning to oil production— he was lifting the federal bans on drilling—the price of oil would start dropping the next day.

  • In 2008, Senator Ken Salazar (D-CO) refused to vote for any new offshore drilling.  In a conversation with minority leader Mitch McConnell (R-KY), Salazar objected to allowing any drilling on America’s outer continental shelf—even if gas prices reached $10 a gallon.  Obama named him Secretary of the Interior.
  • In 2008, Steven Chu, head of the Lawrence Livermore Laboratories at U. of California Berkeley, told the Wall Street Journal that “Somehow we have to figure out how to boost the price of gasoline to the levels in Europe.” he also said “We have lots of fossil fuel; that’s really both good and bad news.  We won’t run out of energy, but there’s enough carbon in the ground to really cook us.” Obama named him Secretary of Energy.
  • During the 2008 campaign, candidate Obama said “Under my plan of a cap-and-trade system, electricity rates would necessarily skyrocket.” And “So if somebody wants to build a coal-powered plant, they can.  It’s just that it will bankrupt them.” He was elected president.

I don’t know if Obama ever took a class in economics, but he seems to be totally unfamiliar with the basic laws of supply and demand.  When supply is restricted, the cost goes up. When the cost of gasoline goes up, so does the cost of everything else.

Goods are transported by truck, and when delivery costs more, the price of your groceries cost more. When the government is busily printing money, the value of the dollar goes down. Oddly enough, the price of gas and the cost of food are not included in the government’s statistics on inflation. You have to keep track of that yourself.

President Obama speaks enthusiastically about his clean, green economy of tomorrow; but he doesn’t seem to understand that windmills and solar arrays produce only small amounts of electricity, which has little to do with transportation, and does not replace gasoline.  Our transportation sector is powered by petroleum, and will continue to be powered by petroleum far into the foreseeable future.  There is no alternative.

Why do I say that an Obama speech turning the energy sector free would start to bring down oil prices right away?  Ronald Reagan did it, and George W. Bush did it.  There is evidence. And the evidence that Obama’s clean, green government subsidized energy will prove to be an effective alternative — ever?  Nonexistent.


7 Comments so far
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How does it follow from the laws of supply and demand that prices would decrease immediately upon a return to normal rates of offshore permit issuing? It can take a few years to begin producing oil from deep water wells. There wouldn’t be any change in supply anytime soon. There should be a small drop in long term oil futures but that shouldn’t impact the spot price significantly. Reagan didn’t cause the oil glut, and to the extent he played a role in lowering prices, it would have been through the elimination of petroleum taxes, not a speech.

There is an alternative to the transportation system, though. Commuter rail would help to reduce demand for gasoline and could be powered by electricity. Simply drilling more is not a solution. Remaining oil fields have higher costs of production.

The BLS does put out a CPI that includes oil and food, but a CPI that excludes them is often used because food and oil prices are more volatile than most and can obfuscate longer term inflationary trends.


Comment by Mufasa

We have history. It has occurred twice, once in the Reagan administration and once in the Bush administration. Oil prices were high, the two president’s removed moratoriums and the next day the price started down. Took months to get all the way down, Oil prices are futures prices and are partly a reaction not only to the turmoil in the Arab states, but also to what ‘might happen’—the unknown. The introduction of some certainty such as ‘America is drilling again’ would change the perception of future dangers.

If you do a little research, you will find that commuter rail has been very popular with mayors and governors who want to be on the cutting edge. Across the country, ridership is poor, commuter trains are not cost effective, and are a drain on the economy. See Randall O’Toole at the Cato Institute. The basic problem with rail is that it is fixed. American population is mobile. Areas go in and out of fashion, but rail transportation still goes to the same place. Most major cities have had rail at one time that they have torn out, before trying again. The Acela train in the busiest East Coast corridor, Biden’s daily trip, is neither packed nor cost effective.


Comment by The Elephant's Child

What moratoria did Reagan remove? The outer shelf moratorium that Bush lifted was only presidential, there was a congressional one as well that remained in force. Oil declined throughout Reagan’s presidency due to global oversupply and reduced demand as a response to the oil crises, I don’t see any reason to attribute anything to a particular action of his although I’m sure his windfall tax removal had an impact at some point. There’s no drop in oil price during Bush’s term that stands out from the noise besides the ones that occurred during the post 9/11 slump and after the housing bubble collapsed due to demand destruction. There’s no supply and demand reason for any next day drop. If such a thing happened, it’s probably due to speculators trying to anticipate an irrational response.

The price for futures a few years out does not determine prices today. Futures contracts are sold on secondary markets and futures prices will converge to the spot price as the delivery date approaches. If market participants know the production isn’t coming for a while, they know that a higher price is still justified for contracts with a delivery date before the production is expected. Futures prices do have some effect through psychology and inelasticities, but US offshore drilling is just a blip on global supply. Its potential to affect price is not even that great, let alone only indirectly through long-term futures prices.

I’m not even commenting on existing rail projects. I’m saying that increasingly difficult to obtain oil and rapidly increasing global demand will mean elevated prices which means rail will be necessary in the not-so-long term. Randall O’Toole notwithstanding, US Transportation Energy Book data shows that commuter rail uses only ~84% of the energy of an average car per passenger mile, even with 2006 ridership. I don’t want to make this too long, but rail faces hurdles like high capital cost which hurts its net present value assessment because it discounts long term energy cost savings. I’m not conceding your other points on rail, by the way, I just don’t want to make this unreadably long.


Comment by Mufasa

We have more oil than Saudi Arabia. Obama is doing everything in his power to keep us from accessing any of it. America’s development of techniques for extracting oil from shale deposits has changed the energy picture for the whole world. We have plenty of oil. Obama seems to believe in global warming. I don’t. He seems to believe that CO2 is a pollutant. That is nonsense. He seems to believe that wind and solar will create a clean green economy, It won’t. Neither will ever produce a significant amount of electricity, wind is too intermittent, solar is too diffuse. Neither has anything to do with the transportation sector. Obama is also still trying to bankrupt coal. Electric cars will not be other than an experiment unless and until we have an unknown breakthrough in battery technology— the same thing that electric cars have been needing since 1900. Engineers say they have exhausted the periodic table of elements and have no ideas. He is starving us of energy with regulation, executive orders, “endangered” species, lawsuits, and regulatory agencies’ refusal to follow the law. I don’t know what he thinks he is doing, but it is criminal and stupid.


Comment by The Elephant's Child

Kerogens in marlstone, commonly confusingly referred to as “shale oil”, is not actual oil and has enormous costs of production and would require huge risks and capital expenditures as well as cause severe environmental damage. This is the kind of “oil” of which US has lots. It is uncertain that any great amount can be economically recovered at reasonable prices and the costs of production will continue to rise with oil price. There is not enough economical oil to hold prices down in the face of exploding developing world demand. Conventional ( usually cheaper) oil production is in decline across most of the world. Only Iraq, if political conditions allow, and Saudi Arabia, although its claimed reserves and capacity are often questioned, show much potential for growth. As we transition to more expensive oil, a greater part of the produce of the economy must take the form of reinvestment in mineral extraction at the expense of consumer goods.

Jeremy Grantham, the manager of GMO, a fund with $106 billion under management has similar view, as do many professionals in military strategy formation, actuarial sciences, and petroleum geology and engineering. I don’t think that alternative energies are a “solution” to the problem, but they will be necessary to mitigate it eventually. There is no “solution” that preserves our current way of life, people must accept that energy will become more costly until some major and unforseeable technological advancements are made and adapt accordingly, in part by building appropriate infrastructure in preparation to ease the transition.


Comment by Mufasa

According to what I have read from excellent sources, you are completely incorrect. New techniques have made oil and natural gas from shale deposits both accessible and profitable without environmental damage. You assume “peak oil,” and a declining world. Just as the entire energy picture of the world has been changed in recent months by new technology, oil may at some point become very expensive. The increased cost is what will spur new technology and new alternatives. Israel, long thought to be the only country in the Middle East with not a drop of oil, but lots of high IQ has made tremendous discoveries, and will become a major exporter of natural gas.

The free market works!


Comment by The Elephant's Child

New technologies have improved fracking and horizontal drilling gradually since the 70s or so, but economic viability has also depended on rising prices. Multi-stage fracking is important but what’s changed most is demand and price. Oil produced from shale has significantly higher average production costs and wells have faster decline rates than do those in more porous formations. Even if there turned out to be enough recoverable oil in shale to offset declines in cheap and easy mature fields, the price should still increase.

Human ingenuity isn’t infinite or very predictable. Technology may continually improve, but it’s a mistake to think that it is virtually a law of nature that you get what you want when you need it. You don’t just buy technological development, there’s nature to contend with. Moreover, spending increasing amounts of money on R&D can itself be a problem if R&D spending and associated things like fixed investment must grow much faster than output.

People will continue to find oil and gas for a long time but they’ll have to look in harder to reach places. Leviathan is deepwater so it’s probably substantially more expensive to produce than the old Arab fields. Can technology keep up? The way things are going isn’t auspicious. Rapid demand growth in the developing world is driving prices way up while global liquids production is just inching up, and that’s driven by NGL growth, which isn’t as useful as crude.


Comment by Mufasa

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