Pain at the Pump

Like Method Man, I came to bring the pain hard-core from the brain, but I’m talking about gas for your car, bus, and plane. Unless you walk to work and don’t have a TV or radio, you are probably aware of the rising price of gas the past few weeks. In fact, since January 2012 the average monthly price of gas has increased almost 14% from $3.380 in January to $3.852 per gallon in March. The price per gallon normally goes up during the spring as people drive more, but according to the U.S. Energy Information Administration, this is the highest price level we have seen this early into the driving season. Many commentators have already predicted $5 per gallon by the summer. That would be just the beginning of our troubles as higher gas prices force consumers to cut back on spending thereby jeopardizing our budding recovery.
Point the Finger
So who is to blame? Blame Obama? Blame Bush? Blame Iran? Blame the Democrats? Blame the Republicans?  Blame the oil companies?  Actually, we can only blame ourselves because we continue to choose to pay $4 a gallon. . . and we haven’t learned anything from our mistakes over the last 10 years.  As long as there is demand, companies will charge whatever price the market dictates.  So while we are quick to say “drill baby drill” every time the price per gallon nears $4, we have simply not changed our behavior.  What we should be doing is purchasing higher mpg cars, utilizing public transportation systems, and simply driving less.  We should be investing in and researching natural gas engines.  These steps would diversify our transportation sector away from its reliance on oil as well as free up demand.  It is simple economics – reduce demand and the price will fall. 
Demand from Emerging Markets
The reality is that we live in a truly global marketplace where one country is no longer a market in itself.  This means that even if the US did start drilling everywhere for oil, it would actually only have a small impact on the world markets.  China, India, and Brazil are all energy hungry and have enough clout to move prices ever higher.  A major contributor to the recent spike in oil prices is the tension between Iran, the US, and Israel.  However, Saudi Arabia said it would offset any decrease in Iranian supplies that result from sanctions.  This still creates uncertainty, and therefore a risk premium. 
The Real Reason for Higher Prices
Actually, there are a combination of reasons for higher gas prices.  1) Increased demand from emerging markets; 2) Tensions in Middle East; 3) Lower production levels worldwide and 4) Price spread between Brent and WTI.  The first three reasons listed here are pretty self-explanatory: it is becoming harder and harder to find the black gold at the same time that global demand is rising.  The oil rich region of the Mid East underwent an upheaval with the Arab Spring and production has yet to come back to prior levels.  Basically, the lowest hanging fruit has been picked from the tree and now we must take on ever riskier (i.e. expensive) projects to access our bounty such as deep water drilling, tar sands, etc.  As long as the price per barrel stays high, these projects make financial sense and encourage exploration and production.  
Refinery Problems
Several major refineries in the northeast have shut their doors in the last few months exacerbating the pain at the pump.  The reasoning behind the closings has to do with the price difference between the benchmark for the different grades of crude.  As of 3/30/12, the spot price for Brent is $123 per barrel and the spot price for WTI is $103 per barrel.  Historically, these two benchmarks have traded within a few dollars of each other.  With the spread over $20 per barrel, the refineries outside Philadelphia that process the Brent are simply not profitable.  These refineries were set up years ago when Brent was the standard benchmark.  Now there has been a shift to WTI as the standard, but the refineries in the northeast can not process that type of crude which is typically refined in the midwest or gulf coast.  This means that a lot of refining capability has come off-line and does not look like it is coming back. 
Conclusion
Until we come up with abundant, renewable energy and scale it to meet our needs, we will fall victim to price shocks for our natural resources.  The US has been doing a great job of decreasing its energy usage through efficiency measures, but there is still plenty of room to improve.  Behavior affects markets, and the law of supply and demand always produces equilibrium.  If we want to avoid being in the same predicament next year, 5 years from now, or 20 years from now, we must realize that we need to end our dependence on the same resources that put us here in the first place.  After all, $5 per gallon won’t hurt so bad when you car runs 100 miles per gallon.

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