When John Gambling recently invited me to appear on his popular radio show on WOR-AM in New York City, he had one question: Why had the price of gasoline again topped the $3 mark in America, setting an all-time record high for December?
We agreed that most of the media seem to be rerunning the excuses used in 2008. Those controlling the crude futures market were again blaming the same old suspects: incredible growth in Chinese oil demand, the weakness of the dollar, falling crude oil supplies in the U.S., and so on. To me, however, the most important fact about high gas prices is exactly how much additional money gasoline costs are taking from our nation—just as we're showing the first real signs of a broad-based recovery.
On the morning of Gambling's show, the futures market for gasoline was sitting at $2.41 a gallon, or 58¢ higher than at the end of the summer driving season. And that reverses the historical trend: Over the past decade, gasoline prices on the futures market have consistently dropped by approximately 20¢ per gallon during that period. So that's a 78¢-per-gallon turnaround. (Note: On Aug. 25, Bloomberg covered a story on technical analysis that suggested gasoline futures could fall to $1.34 a gallon by yearend.)
Multiply that 78¢-per-gallon turnaround by the average 344 million gallons of gasoline American drivers buy each day, and you come up with $268 million more per day that's being diverted from consumer spending into higher gasoline costs—or almost $100 billion a year.
Passing (and Intercepting) the Buck
Of course the oil pundits—whether industry analysts, commentators, lobbyists, or executives—validate the high price of oil. They usually do, saying as always that either gasoline supplies or crude oil on hand is in short supply, hence the increased prices. But that hasn't been true. Gasoline inventories on Dec. 17 were 217 million barrels, slightly more than gasoline inventories in the last week of February 2009—when the price of crude neared $33 a barrel in the wake of the previous fall's financial meltdown.
Likewise on Dec. 17, oil inventories in the U.S. stood at 340.6 million barrels. That's only 10 million barrels less than we had in the last week of February 2009—again, when oil had fallen back to $33.
Fact is, we have more oil on hand today (13 million barrels) and just three million barrels of gasoline less than we did at the end of January 1999, a period when gasoline prices were down near the $1 mark. As for strong economic growth dictating higher oil and gas prices, it should be noted that our GDP grew 5.4 percent in late 1998—and growth would improve to 7.1 percent at the start of 1999. Yet gasoline was a buck a gallon.
It's not just U.S. oil inventories that are considered at the high end of the five-year average. Mohammed bin Dha'en al-Hamili, energy minister for the United Arab Emirates, told the Gulf News on Dec. 25 that "global oil inventories are really high, and the current crude oil prices do not reflect market fundamentals."
Reversing the Law of Supply and Demand
A few days before my appearance with Gambling, an Associated Press story discussed how U.S. gasoline demand has fallen for four straight years. It's down 8 percent from our peak use in 2006, and the story further reported that government officials and the head of Exxon Mobil (XOM) believe that gasoline use in America has peaked for good this time, never to return to 2006 consumption levels.
The very next day CNN Money published a report from the Oil Price Information Service, which concluded, "Based on the current high price of crude oil and historical trends, gasoline prices in the $3.75 range could be a reality by spring."
Yes, it's 2008 redux: Energy prices are rising in the face of four-year weakened U.S. demand and high inventories worldwide.
At this rate, it won't take long until skyrocketing oil and gasoline prices drag the current economic recovery to a halt. Worse, if oil and gasoline prices go up for consumers and business in 2011 by a substantial amount, reducing the unemployment numbers may not be possible.
The fun doesn't stop there. On Dec. 26, John Hofmeister, former president of Royal Dutch Shell's (RDSA) U.S. subsidiary Shell Oil, appeared on Platt's Energy Week television program and suggested we could well be paying $5 a gallon for gasoline by 2012. This time, the Oil Price Information Service's Tom Kloza disputed Hofmeister's time frame but said that $5 gas would definitely become a reality over the next decade. Note to Tom: If your company is forecasting up to $3.75 a gallon in just a few months, Hofmeister's prediction of another $1.25 jump a year later does not sound unreasonable.
The China Excuse Syndrome
We're being bombarded again with PR spin about why oil prices are rising, yet a legitimate reason could exist for higher oil prices—an improvement in the world's economy. But constantly falling back on blaming China's unquenchable demand for rising oil doesn't hold up, because our demand has fallen so much.
In 2008, China was importing 3.671 million barrels of oil per day, and that figure jumped to 4.096 million barrels in 2009. Through the first 10 months of 2010, China imported 4.74 million barrels per day. U.S. importation of oil, on the other hand, dropped from 10.1 million bpd in 2005 to just 9.1 million bpd in 2010. And in the last 90 days, we've imported only an average 8.55 million bpd. True, Chinese demand for oil is up by 1 million barrels per day, but U.S. demand for imported oil has fallen nearly an identical amount over a slightly longer period of time. That would be considered a wash.
More important, it looks like China is getting serious about putting the brakes on its economic growth. The country has posted two interest rate increases in the past few months, and a week ago Beijing said that license plates for new car purchases would be limited to only 240,000 in 2011. That would have the effect of cutting new car sales in that city by two-thirds, or almost 500,000 vehicles, in the coming year.
The Chinese Automobile Manufacturers Assn. is not happy with that decision. Its members rightly fear that such imposed reductions in car selling could spread to other major cities.
Then China announced that the tax credits to promote sales of small engine vehicles would not be renewed.
Something that's still grimly amusing is how, on days when the dollar falls against other currencies, oil traders claim that's the reason oil prices have jumped. But they are remarkably silent when the dollar rises in value, yet oil prices jump on those days too.
Anyone can look at the Dollar Index Spot (DXY:IND) and verify that on Aug. 6 its high trade was 80.94 and on Dec. 27 it was 80.64, or virtually neutral in relation to a basket of currencies. In the same period, however, benchmark West Texas Intermediate crude has gone from around $75.00 to $91.20.
There is also a reasonable explanation why oil should be priced higher than the Energy Information Administration's average-price figure of $33.53 per barrel since 1983: Most of the easily accessible oil (except maybe in Iraq) has been found and is being pumped at a voracious rate.
From now on, new oil will come from deep water, shale, oil sands, or other places equally expensive to extract it from. The days of sticking a pipe into Saudi Arabia's deserts and watching oil gush out under its own pressure are ending. No, the higher costs of these alternative oil discovery and production methods justify to some extent the rationale for higher crude prices. They're necessary to make exploiting that oil possible.
Too Much Money
At the moment, however, oil's high premiums are more likely the result of far too much liquidity in the financial system, available at too little interest. Capital always looks for maximum yield, and paper profits on commodities seem again to be the year's winning ticket.
But be warned: When the day comes that everyone holding an oil contract demands actual delivery of the physical crude on the contract's due date, we'll know we're about to have a real energy crisis. And the day of that legitimate reckoning is coming—just not today or tomorrow.
The fact is that modern societies run on energy, and lots of it. Moreover, the lower the cost of that energy, the better the odds that the world's economies will be doing extremely well. Yet Americans continue to have a major problem with our government's position on liquid energy—it's just one more issue with which Washington is incapable of dealing. Validating that statement is the fact that in the middle of December, the Commodities Futures Trading Commission delayed until 2011 the vote on installing position limits on speculators involved in commodities.
According to Reuters, some of the commissioners felt that moving too fast could damage the commodities market. Really? Here in the real world, everyone paying $3 a gallon for gasoline has been hoping someone would damage the oil futures market.
A Switch to Electric Vehicles?
The continued forward weakness in U.S. oil demand has a lot going for it. First, when the price of gasoline passed the $3 level for the first time in the fall of 2005—when multiple refineries accounting for 25 percent of the nation's refining capacity were taken offline by hurricanes Katrina and Rita—that started a slow and apparently permanent decline in our gasoline use. And now that the first baby boomers have started hitting 65, it would be reasonable to assume that their annual driving mileage will fall when they retire.
Further, if the Oil Price Information Service is correct in predicting that gasoline might hit $3.75 early next year, that fact will reduce our demand for oil and gasoline even more. But it is highly unlikely that the government's new fuel efficiency standards of 36 mpg for the 2016 new-car fleet will do anything to change our overall gasoline demand.
Why? Even when the economy is ticking along fine, it will take decades to replace the 240 million vehicles on the road with more fuel-efficient ones. Besides, the new fuel efficiency standards are only for "gasoline"-powered automobiles.
I believe electric cars will sell better than anticipated (and if gas hits $5 a gallon, they'll fly off dealers' lots) but still in numbers far too low to make much of a difference. Despite the economic incentive, American drivers still cling to the notion they can have both big cars and cheap gas. Look at what happened earlier this year when gas prices fell: Sales of SUVs and pickup trucks began to climb again.
An Abundance of Natural Gas
Here's the prediction. It's time to start the long migration out of the Oil Age, and Chrysler's Sergio Marchionne may have the best plan of all. No, it's not the Fiat 500 coming to a small group of dealers next month. It's the fact that Fiat (FIA) is heavily invested in vehicles powered by natural gas.
According to Robert Bryce, author of numerous books about America's energy needs (and the foolishness of many energy programs): "In 1989, the U.S. had about 168 trillion cubic feet of proved gas reserves. By the end of 2009, proved gas reserves had increased by 41 percent, to some 237 trillion cubic feet. But here's the amazing thing: Over that 20-year period, U.S. gas wells produced more than 370 trillion cubic feet of gas—more than two times as much gas as was foreseen in the proved reserves estimate put forward back in 1989.
"Indeed, despite the enormous amount of gas that the U.S. has produced and burned over the past few decades, the country's proved natural gas reserves are now larger than they've ever been."
That's right, we have a growing glut of natural gas in this country, and we could easily sell more vehicles capable of running on natural gas.
It's not the perfect scenario. We'd need thousands more stations pumping the highest PSI pressures to extend the range of these vehicles. (The Honda Civic GX natural gas vehicle I drove a decade ago had a horrendously low range when I filled it up at a lower PSI filling station.) But, unlike the false promise of hydrogen, this situation is easily corrected at a reasonable cost.
Electric and Gas Combined
The second stage would be to create more series hybrid electrics, such as the General Motors' (GM) new Chevrolet Volt. It uses battery power for short city trips, but instead of its onboard generator being powered by gasoline, that too could run on natural gas—yielding a hybrid electric that uses no gasoline whatsoever.
Obviously, some engineering work would be needed to design a car capable of carrying both the battery pack and a natural gas tank that could deliver what consumers would consider a reasonable range at an appealing price. Yet just as obviously, the technology is here today to do just that.
If the government's new fuel economy standards moved in all three directions at once—electric cars, improved gas mileage, and natural gas-powered vehicles—the impact on the futures market for oil and gas would happen faster and likely be more significant. Then again, just making the announcement that we intend to reduce our demand for crude oil dramatically would likely sink its price back to a legitimate discovery level.
Go After Speculators' Leverage
Peter Drucker, easily the most brilliant predictor of future trends, made his predictions simply by looking at today's reality and moving the trend line into the future to see how it would alter our society. If oil production continues to be constrained against demand, that allows the speculators and volatility to control the market. After all, speculators who never intend to take delivery of one drop of oil continue to plow more cheap capital into those contracts, thereby distorting the real discovery price.
After five years of this costly behavior, it has become clear that they're not going to change if they don't have to. The government could fix this problem quickly by severely reducing the amount of leverage or borrowing permitted to purchase commodity contracts and by raising interest rates. But neither move seems likely.
Natural gas reserves are abundant, though, and we continue to find more of that fuel than we're currently using. And because we own the natural gas reserves, using it to fuel cars offers the very real benefit of shrinking our foreign trade deficit appreciably in the near term.
Alternatively, we could do nothing and continue our present course. And we could look forward every two years to our economy being held hostage—which, when oil markets move past a logical discovery price and consumers divert $250 million and $500 million a day of their earnings from consumerism to fuel needs, does tangible economic damage.
We can keep it up, that is, until the day that oil becomes legitimately worth $250 plus per barrel. By then it will be too late to do anything but extend unemployment benefits for another decade or so.