WHY GAS PRICES ARE TOO LOW by Larry Stout, 6/22/08
WHY GAS PRICES ARE TOO LOW by Larry Stout
I once complimented my Russian translator after a service, and he turned to me and asked, “How would you know if I translated well or not?” He was right, and the same could be said for our understanding of fuel prices. For almost all of us, we have no idea of whether we are paying too much at the pump.
By now, most readers are wondering if I have been living in a cave for the past year, because the price of oil has certainly been rapidly escalating. In fact, the price of gas has more than doubled in the past five years. But, this fact is still not a good barometer for determining if the cost is too high today. It is a matter of economics – supply, demand, and market forces.
First, consider the increase in demand. The expanding economies of China and India especially have greatly impacted the world demand for oil. China alone has seen oil consumption grow by 8 percent annually for the past five years, indicating a doubling rate of less than 10 years. Throughout the world there has been demand for higher living standards and greater urbanization, all of which translate into more and more demand for energy, most often oil.
Now, this would not be a problem if supply would keep up – but unfortunately, this is not the case. The best oil would be that which is easiest to refine, which is called ‘light sweet crude’ because of its low sulfur content. The easily accessible sources of this oil have almost all been exhausted, which is actually a good thing. The cheap oil was the market standard, which meant that any other oil could not be extracted competitively. It never made economic sense to explore “heavy” oil such as Canada’s tar sands region or the American Rockies oil shale areas, which was mentioned during President Bush’s most recent Saturday radio address, but with the higher prices today, these are reasonable alternatives. The fact is, the world is not ‘running out of oil’ as much as it has run out of easy-to-extract and easy-to-refine oil.
Getting oil out of the ground is not much good unless it is refined, but the USA has not built a new refinery in over thirty years. This means that America must import already refined oil, which of course, is more costly than if it would be done domestically.
Yet another factor is that the price we pay for fuel is inseparably tied with the available supply. Royal Dutch Shell was heavily fined several years ago for misrepresenting their available reserves to investors. Think of it like a farmer who sells a bushel of corn in the market, but those buying it know he did not plant a new harvest, so this bushel might be his last. The price of the same bushel of corn changes depending on the knowledge of future supplies of it.
The argument that oil companies make ‘excess’ profits is absurd for anyone that knows anything about economics. No one speaks about ‘excess’ profits for bottled water companies, but the simple fact is that the product they sell is less than 0.1 percent of their costs. Virtually all the price of a bottle of water goes for the bottling process, packaging, shipping, marketing, retailing, and then profit. A gallon of bottled water would cost about $7.00. And that is for water!
Oil companies not only must get the oil from the ground, which as has already been mentioned, is getting more and more difficult, it must also be refined, then transported, then marketed, retailed and what is left is profit. Oil companies spend enormous amounts of money on environmental concerns in all these process stages as well as research and development. If they did not – the company would not be able to stay in business. Consider also that the fall in the dollar has also tremendously hurt US oil companies, as the dollar buys much less on the world market than it used to.
Considering all these factors, it is absolutely ridiculous for politicians to blame oil costs on simplistic reasons like greedy oil companies, or speculators, or OPEC, or American over consumption. The cost of oil is based on a huge number of factors – all interweaving in a complex mechanism of world commerce. So – is it too high? Well, it’s cheaper than Perrier.
I once complimented my Russian translator after a service, and he turned to me and asked, “How would you know if I translated well or not?” He was right, and the same could be said for our understanding of fuel prices. For almost all of us, we have no idea of whether we are paying too much at the pump.
By now, most readers are wondering if I have been living in a cave for the past year, because the price of oil has certainly been rapidly escalating. In fact, the price of gas has more than doubled in the past five years. But, this fact is still not a good barometer for determining if the cost is too high today. It is a matter of economics – supply, demand, and market forces.
First, consider the increase in demand. The expanding economies of China and India especially have greatly impacted the world demand for oil. China alone has seen oil consumption grow by 8 percent annually for the past five years, indicating a doubling rate of less than 10 years. Throughout the world there has been demand for higher living standards and greater urbanization, all of which translate into more and more demand for energy, most often oil.
Now, this would not be a problem if supply would keep up – but unfortunately, this is not the case. The best oil would be that which is easiest to refine, which is called ‘light sweet crude’ because of its low sulfur content. The easily accessible sources of this oil have almost all been exhausted, which is actually a good thing. The cheap oil was the market standard, which meant that any other oil could not be extracted competitively. It never made economic sense to explore “heavy” oil such as Canada’s tar sands region or the American Rockies oil shale areas, which was mentioned during President Bush’s most recent Saturday radio address, but with the higher prices today, these are reasonable alternatives. The fact is, the world is not ‘running out of oil’ as much as it has run out of easy-to-extract and easy-to-refine oil.
Getting oil out of the ground is not much good unless it is refined, but the USA has not built a new refinery in over thirty years. This means that America must import already refined oil, which of course, is more costly than if it would be done domestically.
Yet another factor is that the price we pay for fuel is inseparably tied with the available supply. Royal Dutch Shell was heavily fined several years ago for misrepresenting their available reserves to investors. Think of it like a farmer who sells a bushel of corn in the market, but those buying it know he did not plant a new harvest, so this bushel might be his last. The price of the same bushel of corn changes depending on the knowledge of future supplies of it.
The argument that oil companies make ‘excess’ profits is absurd for anyone that knows anything about economics. No one speaks about ‘excess’ profits for bottled water companies, but the simple fact is that the product they sell is less than 0.1 percent of their costs. Virtually all the price of a bottle of water goes for the bottling process, packaging, shipping, marketing, retailing, and then profit. A gallon of bottled water would cost about $7.00. And that is for water!
Oil companies not only must get the oil from the ground, which as has already been mentioned, is getting more and more difficult, it must also be refined, then transported, then marketed, retailed and what is left is profit. Oil companies spend enormous amounts of money on environmental concerns in all these process stages as well as research and development. If they did not – the company would not be able to stay in business. Consider also that the fall in the dollar has also tremendously hurt US oil companies, as the dollar buys much less on the world market than it used to.
Considering all these factors, it is absolutely ridiculous for politicians to blame oil costs on simplistic reasons like greedy oil companies, or speculators, or OPEC, or American over consumption. The cost of oil is based on a huge number of factors – all interweaving in a complex mechanism of world commerce. So – is it too high? Well, it’s cheaper than Perrier.
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