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By Robert Rapier on Jun 28, 2007 with no responses

Energy Policy Insanity

Just enough quiet time this morning (still suffering jet lag and waking up at 4 a.m.) to knock out an essay. I told my daughter last night that I plan to keep writing, but I don’t plan to do it on their time. I will do it early in the morning, at lunch, or when the rest of the family is occupied with something. But I like writing too much to stop.

I read an article yesterday in The Detroit News:

Energy bill may gouge consumers

The article was written by Mark J. Perry, an economics and finance professor at the University of Michigan, and discusses the pending energy legislation. There was been so much to write about on this issue, but I just haven’t had the free time lately. Professor Perry does a nice job of explaining some of what’s wrong with the pending bill. And believe me, if there was ever an indication that our legislators do not understand energy issues, the pending bills provide concrete evidence (at least to me).

Professor Perry writes:

Despite good intentions, Congress is about to make a huge error in consumer protection and energy security if a House-Senate conference committee ends up approving energy legislation that increases taxes on oil companies and makes gas-price gouging a criminal offense.

I go back and forth on this one. Are their intentions good? Or are they merely pandering to their constituents so they will get reelected? I suppose they may sincerely think they can do both – pass energy legislation that causes no pain to consumers while “punishing” oil companies, and get themselves reelected as a result of their “forward thinking” on energy issues. But it won’t be long before everyone – politicians and citizens – get a great big reality check when these policies drive gas prices up another few dollars per gallon (or cause shortages because price increases are now subject to prosecution).

For Congress to increase taxes on our own investor-owned oil companies and raise royalty rates to pay for a big increase in renewable fuels doesn’t make economic sense.

I agree, but for reasons different than he lays out. As I pointed out in the previous essay, the actual displacement in our fossil fuel consumption would be less than 2% on a net basis if it was even possible to scale up to 35 billion gallons of biofuels per year. And again, I think it is important to reiterate that a substantial portion of that 2% comes in the form of animal feed byproducts (discount the animal feed, and true displacement is a few tenths of a percent). It isn’t like you can burn animal feed in your car.

Perhaps more importantly, the vast majority of that scale up in biofuels is supposed to come from cellulosic ethanol, a technology that has not been able to make it commercially – and shows no imminent signs of doing so even though we have been working on the problem since before man stepped on the moon. But our government seems to think they can legislate technology advances. They hear ethanol evangelists who clearly don’t know the first thing about the technical issues involved, yet tell them that we can scale up and run the country on switchgrass, and so they throw vast amounts of money at the problem.

Professor Perry then points out that private oil companies actually don’t own much in the way of worldwide oil reserves:

In fact, more than three-quarters of the world’s oil reserves are owned by national oil companies from such problematic and potentially unfriendly countries as Saudi Arabia, Venezuela, Russia and Iran.

Only 6 percent of the world’s oil reserves are held by private, investor-owned oil companies like ConocoPhillips and ExxonMobil.

But of course we can always sue OPEC. I mean, have you ever heard of a more idiotic idea? The OPEC countries are not depleting their natural resources fast enough to suit our insatiable demand, so we are going to sue them. Can you imagine if the Japanese passed laws allowing them to sue U.S. timber suppliers, because we aren’t giving them the amount they want at the price they want? How about if Africa sues U.S. corn growers because ethanol demand has driven up corn prices? After all, they are no longer getting corn at the prices they were accustomed to.

It doesn’t make economic sense that our own American privately owned oil companies are so vilified and viewed so differently from other industries. In 2006, the average profits for all manufacturing industries were 8.2 cents per dollar of sales, whereas the average oil-industry earnings were 9.5 cents on each dollar of sales, a penny higher.

More to the point: Oil companies reinvest profits in energy development to support the American economy and make huge capital investments regardless of whether profits are high or low. Between 1992 and 2006, U.S. oil companies invested more than $1 trillion in long-term energy projects.

Those arguments fall on deaf ears. I never understood, if the majority of the public thinks oil companies are making a killing, why more people don’t just invest in oil company stocks. (I guess one reason is that the U.S. savings rate is abysmal). Of course one must wonder, if these companies are really printing money, why they trade at 8 or 10 times earnings. The bottom line is that companies that are investing hundreds of billions to trillions on their business have to make multi-billion profits to justify those investments.

And if you want to know what is really going to happen, and I guarantee you that this is what is going to happen, here it is:

And in the name of supposedly protecting consumers, the Democratic leadership in Congress also wants to empower the Federal Trade Commission (FTC) to prosecute companies and individuals who engage in “price gouging” for gasoline and other petroleum products.

Leaders want this even though a congressionally mandated FTC study of gasoline price increases in the aftermath of hurricanes Katrina and Rita two years ago found no evidence of widespread price gouging or any anti-competitive behavior. The FTC concluded that the price increases were due to the market forces and not to any illegal manipulation by oil companies.

“Price gouging” provisions in the energy legislation could have a chilling effect on the oil market. The severe civil and criminal penalties — substantial fines and possible jail time — would force everyone in the oil industry, from the biggest refiner to the smallest gas station, to reconsider everyday business decisions, including whether they should remain open, particularly in disaster areas.

Gasoline suppliers and wholesalers may choose not to move any additional supplies into affected areas when doing so exposes them to possible fines and jail time if the government finds them guilty of the ambiguous crime of “unconscionable pricing.”

Think about it. You are the owner of a gas station, or a refiner in an area that is about to get hit, or just got hit by a hurricane. Suddenly, either there is a run on supplies as people try to evacuate, or local refineries shut down and your future deliveries will be delayed. Your gasoline inventories start to drop rapidly. Normally, you would raise the price. But now the specter of “unconscionable pricing” and the risk of prosecution hang over your head. What do you do? You have 2 options. You can either run out of gas, or shut your supply down. I would shut my supply down, which would only exacerbate the shortage. And you could thank congress for that.

This Week in Petroleum

Lots of other news to talk about, and hopefully I will get around to those stories before they are stale. One big item to keep an eye on, related to This Week in Petroleum, is that distillate stocks have been coming down rapidly, just as gasoline stocks did this spring. That means we could see a repeat of record high prices in the fall and winter, except this time with heating oil. One could have made a killing in the gasoline futures markets by paying attention to what was happening with inventories back in March. I don’t invest in futures, but if I did I would take a close look at heating oil for winter delivery. A recent OPIS report from a couple of weeks ago laid out the potential problem:

“Heating oil stocks fell by a wintry 2.8 million bbl last week, said the department of Energy, suggesting lively export activity and setting the stage for a big rally once temperatures drop.

It almost seems ridiculous to focus in mid-June on heating oil. But in an otherwise ambiguous DOE report, it is the one product where statistics point to some clear warning signs for the remainder of 2007. Something unusual is happening, and the foundations for a troublesome Winter of 2007-2008 may be in the early construction phase.”

The other thing to note is that gasoline stocks turned back down this week, which was not what analysts had expected. That means gasoline prices may have bottomed out for now, because inventories are still very low heading into the busier driving months of July and August. As I stated in previous essays, historically production draws down in these months. Because we are so thin on supplies, this draw down will likely have a disproportionate effect on gas prices. It is going to be an interesting couple of months.