The government makes more on every gallon sold than anyone in the supply chain.
With gasoline prices crossing the four dollar per gallon line in many parts of the country, the Republican majority in the House and the Democratic-led Senate have taken two very different approaches to address rising energy prices. Last week, the House passed a bill requiring the Interior Department to offer new lease sales in the Gulf of Mexico and off the coast of Virginia. Yesterday, the House passed another bill that would require the government to make decisions on drilling permits within sixty days. And, at the same time that the House was addressing the supply side of this economic challenge, the Senate was demanding that oil companies stop making profits.
Democratic senators grilled executives representing the nation’s five biggest oil companies, criticizing them for providing their shareholders with a return on investment and threatening to rescind tax breaks that the industry currently enjoys. The Senate hearing made for great Capitol Hill theater, and it will surely provide leading leftist senators with some great sound bites to prove to their constituents how hard they tried to fight the evil of Big Oil. But, unlike the House, the Senate did nothing to address the economic realities and energy challenges that we must deal with.
It’s embarrassing to find that United States senators don’t understand, or choose to ignore, the realities of energy production. The fact is that the margins that oil companies operate at have remained consistent for decades as a percentage of the cost of fuel and that government makes more on every gallon of gas sold than anyone involved in the supply chain. The reason gasoline is so expensive is because crude oil is so expensive – period. There is no price gouging. There is no profiteering. Some people like to blame rising prices on something they call “speculation,” but use of that particular word creates a mistaken impression. Crude prices are high because worldwide demand is expanding at a rate we have never seen and nobody is sure how we’re going to deliver enough oil to meet that demand.
Nations that understand what is happening – China and India in particular – are positioning themselves to secure the necessary supply by entering into long term, big-dollar deals for crude. Those kind of contracts reduce the projected supply available in the future and, as any tenth-grader studying Adam Smith can tell you, constricted supply -- and rising demand means higher prices.
Today, worldwide crude oil production pretty much matches demand. The world consumes about 85 million barrels of crude per day, and we produce about 85 million barrels per day. We’ve lived with that kind of balance (plus or minus a couple million barrels per day) for a while. So what’s changed? Three important pieces of the worldwide puzzle have shifted the way the people who drive the market look at the future:
- United States production continues to decline. Despite President Obama’s ludicrous assertion that “we’re actually producing more oil here than ever” the fact is that domestic crude production has steadily declined over the past forty years, from about 10 million barrels per day in 1970 to about 5 million barrels per day today.
- Demand in China continues to increase. China has moved from a total daily demand of about 2 million barrels per day twenty years ago to about 9 million barrels per day today. The Department of Energy expects that demand in China will continue to increase as that nation’s economy grows.
- Unrest in the Middle East creates uncertainty. Until and unless the actual revolutions and brewing revolutions in the Middle East sort themselves out, futures contracts involving suppliers in that region of the world must necessarily reflect the premium that one pays for uncertainty.
The recession that started in 2008 and successful American efforts to reduce energy consumption have heretofore disguised the inevitable problem of increasing Chinese demand for crude oil. For example, over the past five years US imports of crude have dropped from about 14 million barrels per day to about 11 million barrels per day. That’s oil that China could, and did, use without pushing energy markets out of balance.
However, if the world’s economic outlook is improving, as many say it is, then increased demand for all forms of energy must inevitably follow. Energy markets are thus responding to what looks like a tipping point: China is going to need more and more oil to feed its spectacular economic growth, and we appear to have maxed out our ability to produce more crude on a global basis. Might the United States further reduce petroleum usage and thus effectively release more supply to China? Eventually – maybe. But not anytime soon.
In the short term, the only way to knock down gasoline prices would be to send the world a clear, unambiguous signal that we are going to use our considerable skills to ramp domestic production up so as to offset increased demand from China. That kind of move would stabilize markets and return some degree of sanity to the gas pump. The House appears to have received that particular message. But the Senate? The Democratic majority seems far more interested in perpetuating class warfare than it does with addressing actual consumer woes.
Rich Trzupek is a chemist and veteran environmental consultant with over twenty-five years of experience in the field. He is the author of the Encounter Broadside How the EPA's Green Tyranny is Stifling America and the upcoming book Regulators Gone Wild: How the EPA is Ruining American Industry (Encounter Books).