High Oil Prices and Consumer Opinion: A Problem of Perspective
World Energy Vol.3, No.1
By Robert A. Mosbacher, Sr., Chairman, Mosbacher Energy Company
The headline in the New York Times on February 21, 2000 was startling. It trumpeted that a "Surge in Oil Prices Raises Specter of Inflation Spike" based on a $30/bbl. price of oil versus $11/bbl. a year ago. In Houston, the capital of oil, a February 23 front-page story in the Chronicle repeated the theme, speaking ominously of oil hitting $30 versus just $10 a little over a year ago.
And in early March , the Dallas Morning News proclaimed "Gas to soar 20 more cents by May's end, officials say," followed by a subhead that said "Rocketing prices draining wallets across the country." Although placed on the business page, the story was actually written for consumers, decrying a nine-year high of $32.50/bbl. as "causing economic pain for motorists around the country." The example given was a machine operator who must commute about 25 miles daily in his 1991 Ford Explorer, now forced to pay $40 of his $400/week net income for gasoline.
What was most disturbing about these articles was the public mindset they revealed about the "proper" level of oil prices. They contained no balance in their view regarding the current high price. They only dealt with how high the price of oil is today, not mentioning the historic lows, what was the cause of the increase, and how and when it might be alleviated. In other words, they made the high prices sound like an aberration that could lead to crisis.
While oil prices have indeed risen more than $20/bbl. since a year ago, it's appalling that popular news coverage accepts the mindset that the increased price of gasoline is a bad thing. There's very little mention of the benefits from alternative fuels that become feasible in this new pricing environment.
After all, the price of $10 or $11 in February 1999 was the lowest price in recent history - a point that's being ignored in the popular news coverage. The fact is, the aberration is not as much $30, which has been exceeded several times in the last twenty years, but the historically low $10.
An Historical Bargain
Consider some of the facts that underscore this point of view. The average price of crude oil for the last twenty-five years has been just under $20/bbl., and that is before adjusting for inflation. Depending on how you tie oil into the Consumer Price Index (CPI) and inflation, today's price is right in line with other commodities, goods and services at somewhere between $25 and $35/bbl.
The only other precipitous drop in the price of oil, besides 1999, was in 1986 when it plunged to around $10/bbl. The average price of oil over the last fourteen years has been about $17.50/bbl. During this whole period, the price of oil has been well under the CPI and one of the real bargains of the modern age.
Indeed, the good news from the U.S. standpoint is that the cost of oil in the overall scheme of things has diminished to no more than 3 percent of total G.D.P. from 9 percent twenty-five years ago. This means the entire economy is not nearly as dependent on oil as it was then, and a rise of $10/bbl. in the price adds only one-half of one percent to inflation today, compared with the huge impact it had on the nation's economic welfare in the 70s and 80s.
The fact is, most people can afford to pay more for gasoline. A quote from the American Automobile Association in the Dallas News coverage was on target: "We don't think it's going to cause people to stop taking long-distance driving vacations. The economy is strong and people have the money to go on vacation. "The issue isn't that energy prices aren't affordable - it's that they're not acceptable.
The Problem of Low Prices
This average low price since 1986 has been a very mixed blessing. While relatively inexpensive energy costs have certainly fueled economic expansion, in the U.S. we have lost over 500,000 jobs related to the oil industry since the early 80s. Also alarmingly, we have grossly increased our dependency on foreign oil; we now import over 55 percent of our oil, including heating oil and gasoline. That has caused real concern for our national security. Moreover, on a global basis, drilling for new oil has been diminished to the point that the immutable law of supply and demand is about to take over: in most of the world, supply is down and demand is up.
Look what low-priced oil has done to the development of alternative fuels. The nuclear industry is contracting, despite the fact that it has an exceptional safety record and produces electric power with zero hydrocarbon emissions. Concern for wildlife is overwhelming the hydro-electric sector, which also produces power with no emissions. The President's one-million solar roofs program is relatively unheard-of, and the solar energy industry is thriving, but only where it does not compete directly with hydrocarbon-fired power. High-mileage vehicles are not selling well. In increasing numbers, American consumers are choosing gas-sucking SUVs, something that can only happen when gasoline prices are relatively low.
While the Environmental Protection Agency struggles to enforce painful sanctions against motorists and industries in high-pollution areas, people go right on driving low-mileage cars and running power-hungry air conditioners, mostly fueled by oil AND GAS. Yet an economic change that could put all these clean-air technologies on a better footing only gets coverage that motorists must pay more and they don't like it.
Try to tell a consumer heating his home, a trucker moving goods across the country, or even a daily commuter in her own car that oil and gasoline is not a major factor in today's national economy and we're better off with a higher price. Their answer would likely be, "It feels like I'm being ripped off." Unfortunately, the truth is that American consumers have been spoiled by unrealistically low prices, and this mindset will not easily be replaced.
Pricing Dynamics
There was a time when the causes of oil price swings were less visible than today. In fact, energy is a commodity and its price has always been a function of supply versus demand. OPEC nations, with leadership from Mexico and help from other countries, have curtailed production for almost a year now, and this has been the proximate cause of the price rise. But except for a few countries such as Saudi Arabia and Kuwait, there is not much room between what they are producing today and what they are able to produce - in other words, there is not a lot of readily available oil production to meet the increasing demand.
In the pages of this magazine, we have read the words of Mideast oil producers who say they are very sensitive to the level of energy demand, and do not want prices to reach a point where demand fails to continue its current growth, much less contracts. Those issues will probably be much in consideration as the oil ministers meet March 27 to decide whether to continue with the current production levels. Regardless of the decisions made, the Energy Department says gasoline prices will still be up this summer, because it takes time for an increased level of production to make its presence felt in the marketplace.
And if prices do remain high this summer, an election-year fall will then be upon us. What does that portend? We've heard some rumblings about utilizing the U.S. Strategic Petroleum Reserve as a way to put downward pressure on oil prices. That would be a mistake, of course. Use of such a tool would not only work against harmonious relations with the world's producing nations but also would be contrary to a long-held U.S. policy of free and fair trade and look as if the U.S. were trying to fix world oil prices. Actually, the price spike will probably be long gone before a drawdown on the SPR could have any real effect. That reserve should be held for a true international crisis, not a consumer backlash.
Future Price Movements
If oil prices settle down later this year to the $20 to $25 range, as many predict they will, oil will no longer be a front page topic and will once again be an important part of our engine for growth without inflationary worries.
If our forecasts are wrong and the price stays around $30 or even higher, there will be several factors that will bring prices down on a longer-term basis. First, there will be more drilling in such places as the deep water off the petroliferous coasts of many countries of the world, including the U.S. Gulf Coast, where deep water drilling, developing, and producing are already going on, the coast of Brazil where there is similar drilling, the coast of Africa with its deep water exploration, and many other areas that are not as far down the exploration trail.
The remarkable technology of putting pipe and completion materials to produce and transport oil from water which is 8,000-feet deep has been proven. The ubiquitous deep waters of the world have great potential for additional oil and gas reserves, but drilling in 5,000 to 10,000 feet of water and then drilling through many thousands of feet of sand, shale and other formations makes for huge costs. Such oil is very expensive to produce and in many cases, can only be justified with higher prices for oil, at least $25 to $30/bbl.
There have been many other innovative developments to help fund and develop oil and gas reserves which will bring more oil to the market at reasonable costs. These include 3-dimensional seismology which can map structures that could contain good quantities of oil or gas. Horizontal drilling through oil filled, though often low deliverability formations, can expose more producing section and raise deliverability. There are many other new developing production enhancement techniques on the horizon.
Where Is The Greater Good?
If sustained, $30+ oil will focus more attention on the experiments and the development of synthetic fuels, solar energy, wind power, gasification of coal, and myriad other technologically feasible but costly methods of producing energy that languish when there is cheap oil.
Even if the control of oil prices were in U.S. hands, which it is not (beyond the quasi-effective jawboning of the OPEC nations), we would still face a daunting decision. Would we be better off with low prices today (under $20/bbl.), thereby keeping the "engines" of our economy running with no inflation for the next couple of years? Or should we take the longer term view of not worrying about today's $30 price because it will bring more activity both in the traditional drilling and production of oil, and because it will invigorate the alternative methods of producing energy? Remember, in the long-term, even if bent by cartels, i.e., OPEC, the law of supply and demand is still in force.
We in the energy business understand the issues in oil pricing, but the typical consumer does not. Which means we in the business are not doing our job explaining the pitfalls of cheap oil to the most important people in our industry - our consumers.
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