The rest of the EnviroHumanImpact staff and I have discussed this topic ad-nauseum but I think it deserves some attention here. Hopefully, this can establish some groundwork for many following stories and commentaries on what is an incredibly complex topic.
The main question I’d like to pose is, “Is $4.00 per gallon gas ultimately good for the environment, the economy (particularly the U.S. economy), and you the consumer?”
What’s causing the massive increase in the price of gas?
Let’s answer first why we have $4.00 per gallon in the U.S. in the first place. Most economists and laymen alike will tell you that it boils down to two main things: 1) Global Demand: Rapidly increasing world demand thanks to explosively developing countries such as China, Malaysia, India, Tawain, Brazil, and the list goes on and 2) Market Speculation: Speculators on the world markets bidding up the prices in order to profit on the commodities markets, specifically crude oil.
Global Demand vs. Prices
So how about those emerging markets? Well, they’re on their way out of the stone-age and into the modern era, going straight from third-world to first almost overnight! So with literally millions more people able to afford automobiles that are increasingly available with the needed fuel and road infrastructure in place and expanding, it not just U.S. consumers using the gas anymore. But as we’ve seen in the U.S., as prices increase, demand feels the squeeze, right?
According to an article at CNN.com, demand for gas actually fell in the U.S. this March by 4.3% year over year. How about a little perspective? That’s the first time the month of March saw a decline since 1979 and the greatest decline (4.3%) of any month of the year since 1942!!! So the economy works, prices rise and demand falls. Once demand falls, prices should realign and come back down, correct?
Wait, demand fell in March by over 4% when the price of a barrel of oil was between $100-$110 per barrel and since then, we’ve seen oil peak at over $140 per barrel! So where’s the disconnect? Well, surely there is some speculation; however, until the last week or so, many of these developing countries had remained committed to providing their residents with cheap fuel using government subsidies.
So as prices increase in the U.S. and around the world, those countries’ demand has decreased but in many of them, prices just have not increased like they have in the U.S. Their demand does not go down because their prices have not gone up! Their governments know that in order to foster their rapid growth, cheap fossil fuels are essential in the short term, similar to the subsidized building of railroads and interstate highways in the U.S. (and the subsequent maintenance). Well, that is until they begin to basically bankrupt those governments in the process.
For instance, according to an article on Forbes online, Malaysia is a net exporter of oil and subsidizes its fuel to the tune of over $16.5 billion a year, or approximately four times the combined budget for national defense, education, and healthcare! Well, with crude oil between $130-$140, they just cannot keep it up forever, so they just raised their price of gas by 60 cents per liter, which is an increase of about 40%.
Who else has felt the heat and changed their approach on fuel subsidies? Only China, India, Indonesia, Sri Lanka, Tawain and Pakistan! Obviously, some pretty major world demand drivers are starting to take action on reducing their subsidies. All the while, many of these countries are battling rapid inflation, as high as 25% according to some experts! It will be very interesting to see if world demand decreases as more of the subsidies are removed, hopefully (at least from U.S. consumers’ perspectives) resulting in a decrease in crude prices.
Don’t forget about Speculators
While some economists will claim that the 20-30% of the price of any good traded on the open markets is the result of speculation, it’s clear that speculators are playing a significant role in the price of oil based on the volatility of the commodity’s price. It’s not just the actual users of crude pushing up the prices, it’s hedge funds, banks, and virtually anyone else with access to crude on the futures exchanges! And because of its ubiquitous use in so many products and in the vast majority of shipping products and raw goods, oil’s high price has a wider impact on the economy.
But step back a moment and assume the role of these investors or “speculators.” Granted hindsight is always 20/20 but consider the following and how they influence speculation (as opposed to actual supply and demand):
- Wealth in numerous emerging markets is exploding for millions of people who are buying cars and consuming more oil and petro-products than ever before.
- With new countries representing a larger percentage of the overall market, prices are less and less tied to just U.S. demand for crude.
- While the price for crude literally skyrockets, these countries fail to feel the pinch as their gasoline prices are subsidized by their governments.
- Top oil exporters, such as Saudi Arabia, have claimed in the past that their production capacity is maxed out; however, even with their recent statement (see link later in this article) to ramp up production, their “sour” crude is more difficult and costly to refine since it’s not “light and sweet.”
- Countries like the U.S. refuse to drill in environmentally protected areas where billions and billions of barrels may exist, giving speculators reason to believe production will remain close to the same. It is estimated that upon a decision to drill (certainly an environmentally contentious decision) that it would take ten years for any of the oil to reach the market.
- From an investment standpoint, energy (especially crude) has really been the only sector bringing consistent positive returns over the past 6-9 months, compared to the overall U.S. market, which is down about 13% in that same period.
- U.S. refining capacity has stagnated so that even if output of crude oil were increased, the amount of oil that the U.S. would be able to put to market would also be limited in the short term, meaning continued high demand on a tight resource.
- Since crude oil is priced on the open market in U.S. dollars, the weakening of the U.S. dollar has significantly driven up prices for the United States
So again, assume the role of speculator and what reason do you have to believe that prices are going anywhere but up based on the global macroeconomic picture? Without change in some of the above situations, the speculator’s main fear is the “bubble” bursting and prices dropping significantly overnight. The question remains whether this is truly, “speculation,” or rather if the increased demand is being built into the price of oil. Consider Iron Ore, which is not traded on the open market like crude but has also seen a 96% price increase over the last year. Perhaps it really is just growing demand from emerging markets.
Changes on the Horizon
As mentioned earlier though, some of these points are changing or have already changed. Developing nations are cutting fuel subsidies like tone-deaf American Idol contestants, Saudi Arabia has recently changed its tune on production capacity, and President Bush and many other lawmakers are making the very contentious call for U.S. drilling off its coasts and in ANWR. Even if some of these never come to fruition (and perhaps some won’t from an environmental standpoint), they at least signal changing winds and may help to cool some of the rampant speculation that has seen little reason to simmer otherwise, however experts say a decade or more would pass before any of that oil could reach the market.
The big point here: Investors (or speculators) are not necessarily investing based on current, actual supply and demand but where they see prices going based on many of the aforementioned points. Ultimately, just signaling that any of these might change could be enough to curb their bullish betting.
What about the Environment?
So what does $4.00 per gallon gas mean for the environment? Well, unfortunately, it doesn’t mean that less gas and oil is being consumed around the world compared to when it was at $1.25 because more people are using more oil than ever worldwide.
What it does mean is massive change in already developed countries, specifically the U.S., Canada, most of Western and Eastern Europe, among others. Recent fuel prices have been a firm wake-up call to all U.S. consumers and businesses that our, “dependence on foreign oil,” is not just political posturing but a real and potentially crippling problem that must be addressed, because of the limits of the resource, not to mention the envirohuman impact of consuming it as if it were water. Still, some persist in the idea that we should simply find more supplies of oil, even though it will in all likelihood remain extremely costly and supplies are ever shrinking as demand increases.
The answers: 1) technological innovation in the form of alternative fuels and energy, increased efficiency in cars (less weight), and cars that can run on electricity (which can be derived from clean wind, solar, and hydro- sources), 2) reduced use by consumers (already in progress), meaning a needed expansion in rapid mass transit, 3) better urban planning, where a consumer needing to save money on fuel literally has the option of public transportation, walking or biking to many of their destinations, and 4) infrastructural changes that will make hybrid cars, smaller cars, plug-in, and hydrogen cars all more than feasible options.
The last 12 months have seen more attention to developing alternative energy by consumers, politicians, and corporations than ever before. While much of it may be just window-dressing, much of it is not. The economic viability of various energy projects may not have been possible with competing means (read: oil) as cheap as they once were, but with oil over $140 per barrel, these projects are seeing new life.
While environmentalists have called for alternative fuels and fuel conservation measures for years, it may just be the free market that moves the world into those fuels after all. Better late than never for some, quite a bit late for others. And the free market has yet to actually solve the problems of fuel shortages, ensuing increase in cost, and the associated pollution due to rampant fuel use and abuse (Hello, Hummer).
Whose Economy stands to benefit or be damaged?
The effects of $4.00 per gallon gas has left the world at somewhat of an economic crossroads. We are in the middle of a gigantic shifting of wealth from heavy oil consuming nations to heaving oil producing nations. Globe and Mail recently ran a fascinating article depicting what they call “The Dubai Miracle.” Basically its all about how all of the “new money” is taking hold in these middle eastern oil producing nations. The changes are, quite frankly, unbelievable.
Ultimately, it’s another case of the “haves” and the “have nots.” Or perhaps the “Have Oils” and “Have Not Oils.”
So, in the short term, countries like Saudi Arabia will see the most unbelievable economic boom of their long and storied histories while the U.S., Canada, and Britain will try to keep their economic heads above water until they can develop viable alternatives to oil. Alas, the silver lining, consider it the new “Space Race” or rather the “Race to new Energy,” which will hopefully yield healthier, less polluting, and less dependent economies.
While the U.S. will hopefully make a renewed push towards alternative energy, which may or may not be subsidized by the government, they won’t be the only ones, and many in the industry would rather oil remain king. What we do have is an opportunity to innovate and develop the “next big thing” and hopefully prosper immensely from it. Provided the world does not end in nuclear war, there’s always another round to be played, another inning to take, another quarter to conquer. It seems pretty clear who’s winning right now (or perhaps just catching up), but the big question: Who’s got next?
What about You?
Finally, where do you, the consumer, the mom, the dad, the employee, the small businessman, or teacher fit in with gas at $4.00 per gallon? Well, unfortunately, there is no easy short-term fix (assuming you’re not one of the “Have Oils”). Sure you can cut back on your consumption of oil and gasoline wherever possible but for many, riding a bicycle to the office just is not an option. Some will find ways to alter a diesel engine to reuse cooking oils at restaurants and others will purchase a more fuel-efficient car or use public transportation if its available.
So in the same way the company you might work for is trying to keep its head above water despite the price of fuel, you too can keep your head above water by focusing on simple ways to limit your consumption, whether by owning a smaller, more fuel efficient vehicle or switching to non-petroleum based product alternatives. You can use a reusable bag and reusable water bottle to reduce the amount of plastics, made from oil, you consume. Even the little actions add up when multiplied across the population. Encourage yourself and friends to support companies that are helping make the leap into the 21st century alternative fuels because their success just might bring the next “Dubai Miracle” back home to your backyard.
What do you think is causing the rise in prices? Disagree with the author? Tell us about it below! We love a good debate!