Wednesday, August 24, 2005

Supply and Demand for Fuel

Here is a letter to the editor of my local paper. It has been a few days already. I don’t know if they will publish it. The information is readily available in nonfiction literature.

Dear Editor,
Friday’s paper included a letter expressing frustration with gasoline prices, and some disgust with oil companies for price gouging. This merits some discussion.

As individuals and families, high gas prices will no doubt hurt our bottom lines. We should understand the underlying economics as much as regular citizens can.

High gas prices are driven by high oil prices. High oil prices reflect such things as the “terror premium,” political instability, and short term speculation. However, there are still fundamental supply and demand concerns influencing the current prices.

Demand has risen tremendously the last few years. Domestically, the US has moved away from passenger cars to light trucks for daily driving. We have also continued our suburban expansion of the last several decades. This means that Americans are driving farther in less efficient machines, increasing demand.

Internationally, demand has increased even more. India is industrializing at a rapid pace. This will increase demand for oil. China is industrializing even more quickly. The Chinese are growing their economy at around 10% per year and they desire an auto-oriented society. China also uses petroleum for electricity. The demand side of the petroleum equation is staggering to say the least. Demand growth abroad has more than outpaced brisk demand growth here at home.

Turning to supply and delivery, many agree that our petroleum extraction and delivery infrastructure is stretched to its limit. We may not be able to produce more petroleum without global capital investments in the hundreds of billions of dollars. Infrastructure won’t be built unless petroleum prices remain high enough long enough to assure these investments’ profitability.

Further, excess petroleum on the market tends to be of lower quality than what the US is set up for. US refineries tend to be set up for light sweet crude, not the heavier, more sulfurous “sour” crude. Running lower quality crude though such refineries may damage them.

Finally, there are sober, rational, conservative people who suspect that new reserves may not be able to replace the oil extracted. They would argue that we are soon entering an era of depletion, where oil supply will fall slowly and steadily, by a few percent per year.

Supply and demand are tight enough that seemingly minor political troubles send the price of oil bouncing. In order to increase supply, the whole world is going to have to invest in exploration and discovery, in development of new wells, in increased exploitation of old, and in developing the kind of infrastructure to handle the cheaper, lower quality oils.

We must treat fuel like the commodity it is. When prices are high, we need to substitute and conserve where possible. Find ways to decrease the miles driven by your family by consolidating trips, walking, or riding bike if feasible. It is possible that many will substitute and conserve, leading to lower prices. Longer term decisions include more efficient vehicles, and living near work and your children’s activities. The longer term options are worth thinking about as protection against future volatility. In a free market economy like ours, the individual needs to be informed and act rationally, to protect his or her wealth and well being.

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