[Blogpinion] Making Cents of Lower Gas Prices

November 24 2008 / by joelg
Category: Energy   Year: 2008   Rating: 6 Hot

By Joel Greenberg

What Happened?

Gas prices have dropped to under $2/gal at some gas stations around the country. “It feels like the 1970’s, with people waiting in line for gas,” one observer says as she waited to fill up at almost half the price of what she was paying earlier in the year. But unlike the ‘70’s (or two months ago) there now seems to be plenty of supply.

So why are prices so low, almost two months after gas shortages in places like Atlanta, due primarily to Hurricane Ike? (Click here to read a twitter history of Atlantans and their search for gas.)

The simplest answer appears to be the low demand as a result of the slow down in the economy worldwide, according to the federal Energy Information Administration.

As Amory Lovins points out, we can lower our demand faster than Saudi Arabia can lower their production, although his idea is to lower demand with more efficient vehicles, not via a global economic slowdown.

Why is this important to the Future of Energy?

Oil is primarily used for transportation in the United States, not electricity generation. While low oil prices are appealing, there is a down side: a false sense of security. The false security could make us less likely to invest in the R&D needed to bring about alternatives to oil, like electric vehicles, wind, and solar.

Demand is low all over the world, including India, China, and Europe. The freezing of credit worldwide has the unintended consequence of making visible the strong causal link between economic activity and energy use.

The more cynical discussions turn to Saudi Arabia lowering the price in order to drive out their competition of Iran, Venezuala and Gazprom. While there is opportunity for some manipulation of the price by companies, countries, or speculators the economic downturn seems to have the affect of overwhelming those actions and therefore being the most likely explanation for the lower oil prices.

Unpredictable oil prices may provide short term relief for consumers, but the up and down swings in price have a larger effect in deterring investment in both petroleum production and alternatives. We run the danger of once again being frozen into R&D inaction when prices are low at least some of the time. This inaction could have a corrosive effect on things like passing tax credits for the renewable energy industry, or customers demanding more fuel efficient cars.

“There are lot more Priuses for sale this month than last month,” one new Prius owner recently told me.

While it’s become a cliche to say to we are in a dysfunctional relationship with oil, it is still an accurate description. It’s as if oil loves us one day (low prices) and hates us the next (high prices). It doesn’t matter how little oil loves us, just so that it gives us some sweetness every once and a while; we’ll still believe enough stick with it throughout the bad times. If prices were always high, we could plan. But if they’re up and down, the danger becomes we don’t plan, holding out hope for lower prices sometime in the future. The worse case scenario becomes that we become incapable of planning our exit off of oil, much like the woman who can’t leave her abusive husband. The fact is, oil prices will rise. The question is, will we plan for that inevitable time? Will we take this opportunity to put money into alternatives?

What to watch for?

The chart above shows a clear upward trend on gasoline prices, except for the past few weeks. That trend is caused by increased consumption in the US and worldwide.

The price of oil will largely depend on three things: 1) the growth of economies worldwide, 2) the ability of oil producers to ratchet supply up and down to meet demand, and 3) the success of substituting oil as a transportation energy source.

When the economy gets going once again, demand will increase, so expect oil prices to rise.

However, two kinks could unexpectedly cause pain. The first happens if one nation’s economy takes off, but others don’t. For example, let’s say China’s economy takes off, but the US economy drags behind. Demand will increase in China, but prices will rise in the US before the US able to absorb them. However, this scenario would be short lived, seeing how interconnected we are in a global economic world.

The second scenario happens if demand outstrips refinery capacity in the US, which was an explanation for high gas prices after hurricanes in the Gulf of Mexico that wipe out refinery capacity for short periods. In this scenario, oil prices would be relatively low, but gas prices would climb hire.

It’s a little surprising how slow oil producers are in ratching down supply to meet lower demand, resulting in lower prices. OPEC is meeting December 17th to discuss lowering production in order to shore up the price, so it’s clear that supply will shrink. In the meantime, the lower gas prices are strong evidence to Lovins’ point that we can lower demand faster than the oil producers can lower supply. However, if they ratchet down supply, prices could increase if the economy has money or incentive to pay for the higher prices.

That’s now a much larger “if.”

Here’s one reason why:

With every major car manufacturer announcing a plug-in hybrid or electric vehicle available within the next three years or so, like BMW’s Mini E announced at the LA Auto Show, there is a real possibility that demand could decrease, even as our economy gets back on track, if enough PHEV’s and EV’s are purchased by the American public over the next five years.

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