(MINNEAPOLIS) – Republican representatives in Congress are introducing bills to limit environmental regulations and expand domestic production, including the Gasoline Regulations Act and the Strategic Energy Production Act, both aimed at lowering gas prices at the pump and expanding domestic oil-and-gas leasing. A Republican super-PAC blames Obama for rising gas prices. And other conservative leaders are personally attacking Obama on this point in press releases and tweets spotlighting increases at the pump.
But, does any of this make sense? When we look at the history of gasoline prices and what has moved them up or down, we’ll see something very different.
Are gasoline prices really that “high”?
We all remember times when prices were lower. But years ago, incomes were lower also, so as with any historical analysis involving money, we have to correct for inflation. The U.S. Energy Information Administration (EIA) has data on various inflation adjusted energy prices back to 1949.
From 1949 up to the OPEC price shocks of the 70s, gasoline prices were slowly falling in real terms. After the 70s, prices dropped back to pre-oil shock values and stayed relatively constant until about 2000 when they began an upward progression, interrupted only by the 2008 recession.
The price (not corrected for inflation) consumers were paying at the pump went from roughly $3 a gallon to $4 over the first six months of 2008, then fell to $1.60 a gallon by the start of 2009 and returned to the $3.50 to $4.00 range by January 2011 where it has stayed ever since.
So while it is true that gas prices are high relative to the 70s, it would be more accurate to say that in the last four years they’ve been stable – except for the start of the recession.
So why do we think gas prices have increased so significantly? It’s easy to remember the pain of a swiftly increasing price and easy to forget when prices when down. So, probably, many of us remember the quick and significant rise in the first part of 2008 and the big rise in 2010 – and have forgotten that prices went down in between.
The real story is the rise in prices from 2000 to 2008. That period does represent a break from post-WWII patterns. But before we can explore that, we have to consider a couple of common views of prices.
Staking out a defense
Both the left and the right have explanations for why gas prices are going up, or might go up in the future, explanations that favor their own views. The right blames high prices on environmental regulations restricting production. The left points to the run-up of war fever against Iran with the embargoing of Iranian production.
What effect has environmental regulations had on oil production? There would be many factors involved in answering this. One approach is to look at the number of oil and natural gas wells being drilled in the U.S. That data is collected and published by Baker Hughes, an oil-field service company. They report that the wells drilled in the U.S. increased from 1,032 in 2003 to 1,880 in 2007, declined with the recession to 1,086 in 2008 and then increased again hitting 1,875 in 2011. Data for Canada shows a similar pattern. The figures for 2007 and 2011 are the highest numbers for the entire period 1987 to 2011. It seems clear that whatever the impact of environmental regulations, it hasn’t impeded a significant increase in the number of oil and gas wells being drilled.
What about the effect of rumors of war with Iran? In January of 2012, the European Union and the U.S. tightened sanctions on Iran, including efforts to place an embargo on Iranian exports of oil. Iran is the world’s third largest exporter of oil, hitting 2.2 million barrels a day in 2010. It is a reasonable assumption that removing this much supply from the world market would tend to drive up prices. A threat of a war, with longer disruptions to Middle East production and perhaps the closing of the Strait of Hormuz, a transit point for 35% of the world’s seaborne traded oil, could have even bigger impact on prices.
But, these are anticipated effects, not yet actual ones. They may have driven up the cost of oil futures, but their impact is more speculative than actual at this point.
Supply and demand
In a perfect market, oil prices would be determined by supply and demand. Of course, the oil market is a long way from perfect, yet, supply and demand factors seem strongly linked to the long term movement of gasoline prices.
During the long slow decline in gasoline prices in the 80s and 90s, U.S. domestic production of oil also declined from about 10 million barrels a day to about 5. Once prices started back up again, domestic production increased and will likely touch 6 million barrels a day in 2012. When natural gas and other types of fuels are included the rebound in total production is more significant.
Oil is a world commodity. And over the period 2000-08 two significant trends stand out: a dramatic increase in the demand for petroleum in the developing world, and a production system being pushed to maximum capacity.
The increased demand for oil is widely cited by sources as diverse as Chevron and the Energy Information Administration. EIA data shows a world-wide increase in petroleum consumption of 11% between 2000 and 2007. That hides a 64% increase for China, a 38% increase for India and an 18% increase for all of Central and South America. By contrast, U.S. consumption actually went down 1% in that period.
Oil is produced and then consumed, not much of it is just stored someplace. But certain countries have excess capacity; the ability to increase oil production in the short term to counter increased demands and stabilize prices. For years, Saudi Arabia played this role. EIA has estimated the spare capacity of all OPEC nations, which, in their view, are the only producers with significant spare capacity. That excess was above 4 million barrels a day in 2001 and 2002, but was 2 million barrels a day or less from 2003 to 2008, the period of the runup of prices.
And of course, oil needs more than production, it has to be refined. In the years from 2000 to 2008 U.S. refineries were operating very close to 100% of capacity. There were anecdotal reports in the media at the time of refinery operators deferring maintenance because they simply couldn’t afford to go off line long enough to do it.
It seems reasonable therefore to suggest that the major reason prices went up from 2000 to 2008 was scarcity of production, the main reason they dropped in 2008-09 was the decline in demand due to the world-wide recession, and the reason they have picked back up since then is the recovery of demand and further growth, especially in the developing world.
Disrupting the system
When interconnected systems of almost any type start to run near capacity, the impact of minor interruptions starts to increase. A system at 70% of capacity can absorb an outage to some of its production much better than a system at 98% capacity. We can see this across a range of complex technical systems including electric power production, for instance.
And in recent years there have been a series of disruptions to portions of the oil production system. The Libya conflict of 2011, ongoing threats to oil production in Nigeria, and pirates attacking exports from Yemen are some recent examples. The Deepwater horizon spill in the Gulf of Mexico of 2010 is fresh in our minds. Each disruption triggers a round of speculative increases in oil prices that only slowly come back down. Looming ahead is the potential disruption to Iranian supply.
The inevitable future disruptions to a stretched system, combined with recovering demand pushing the system even more, seem likely to keep prices for oil bouncing upward, at least in the for a few years.
Is cheap gasoline an American right?
Sometimes Americans can act as if they expected low gas prices as a matter not just of convenience, but as of right. Being “on the road” is a strong cultural symbol and our geographically dispersed nation and history of low prices for gas has led to lives that require a lot of driving. If Americans are told that higher prices are the result of conspiracy or an intentional attack on their lifestyle, it is easier to understand where the anger comes from.
But has we’ve seen, increased world demand and a limited supply seem a far more significant explanation of why $4 a gallon gas is likely to stick around.