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Saturday, January 1, 2011




Energy Unintelligence

Last updated: January 3, 2011

January 1, 2011


I stumbled by chance upon a certain Mark P. Mills who posted an absurd critique of Thomas Friedman's latest rant against America's addiction to oil. There is almost nothing in the post that I can agree with, but I would like to comment only on a few points because these seem to be very common misconceptions held by many people and not only MPM.

First, regarding U.S. dependence on Saudi Arabia: about 5 percent of what we burn, and thus about 10 percent of what we import, comes from the Saudis. America’s number one (and rising) source of imported oil is Canada – over double the amount we get from Saudi Arabia. It’s hard to sustain a good rant about depending on Canada. (Although it is true that Canadians do rant about depending on the American entertainment industry, but that’s another story.) America could stop importing every drop of oil from the Saudis without much difficulty, by ramping up imports from elsewhere (or even ramping domestic production, if we really wanted to). It’s not the U.S. that is particularly dependent on the Saudis per se, but the world. To the extent that we make the world’s problems ours, well then so be it. But facts are facts.

Source: Energy Intelligence

Now I am pretty much sure that TF knows that the bulk of the US petroleum imports does not come from the Middle East. Yet, I am also sure that TF is also perfectly aware of the fact that the price of oil is set globally. Basically America can substitute the Saudi oil with any other oil and maybe even stop buying oil from the Middle East completely, but this is unlikely to have any major effect on the global price of oil. However, the global oil market is constantly observed slumping to any sign of gasoline glut in the US and this is what Thomas Friedman is ranting about all the time.

Basically, the thrust of TF's argument on energy comes in two points. One, America's dependence on petroleum imports leaves it bogged down up to the neck in the Middle East. Two, by cutting its petroleum consumption America can crash the global market making Iran's and other nuts' oil revenues evaporate into the thin air. As a matter of fact, half way through his post MPM agrees with the second point himself. So what's the point of arguing about this really?

In fact, it's immaterial whether Americans replace gasoline and other petroleum products with more expensive alternatives or would just consume less, MPM got this one wrong too. It's really all about how much of the US petroleum demand is leaking to, or better sweeping clean, the global market and right now the US accounts for between 20%-25% of the global demand. TF does not claim that the US depends on the Middle East because it buys its oil from the Middle East, but because, as long as America keeps importing such huge volumes of foreign petroleum, it needs the Middle East to continue pumping the global market with Arab and Persian oil to keep the prices at bay. In this sense the US is more than dependent on Saudi Arabia.

To put it short, for the US to extricate itself from the Middle East and stop funding, directly or indirectly, the Arabs, Persians, Russians and Hugo Chavez, the US should indeed stop its petroleum addiction, or, at the very least, to contain this addiction within its borders. It does matter how this addiction is defined because ridding oneself of an addiction to imports can be achieved by substituting imports with locally extracted petroleum. This will be just as effective geopolitically, even though it would hardly amount to ridding America of the oil addiction as such.

To be sure, there should be some factors that can mitigate the impact of a decline in the US oil consumption on the Middle East. Venezuela, which accounts for close to 10% of the US imports, may fail to find enough refineries capable of processing its low quality oil outside the US. This may limit Venezuela's ability to divert its supplies elsewhere. Basically this part of the impact is very likely to be very concentrated in Venezuela with few escape routes for Chavez to ship the pain out of the country to other oil exporters. In practical terms it changes little since Chavez has long ago transformed his regime into the greatest destabilizing factor in Latin America and globally by bankrolling the narcogeurillas in Colombia, Fidel Castro in Cuba and other nuts. When TF talks about petro-dictators, he certainly holds Chavez to be one of them.

Another factor pertains to the fact that by far the biggest US petroleum supplier is Canada which accounts for 20% of the total imports. Much of the Canadian oil is an alternative oil the Canadians squeeze out of tar sands. Not that Canada should have a major problem to diversify its consumer base and divert its supplies to other parts of the global market, but this is an expensive oil to produce. Canada's tar sand industry is very likely to be the first to go out of business if the price of oil sustains a protracted and deep decline. At this point, other exporters will certainly see their revenues drop but Canada, who operates on thinner profit margins, will probably absorb the brunt of the pain shock. After such a decline the global market may stabilize for a while with the supply harmonized against the demand by the disappearance of an important producer. But, Canada aside, a short look at a graph at the end of the post should be enough for most people to figure out what a devastation can the US wreck with the global oil market by cutting on imports.

When it comes to practical suggestions, MPM seems to be unduly obsessed with the lack of cheaper alternatives. But who said energy should be cheap in the first place? THE CHEAP IS THE ENEMY OF THE SUSTAINABLE. The US would have never had to import oil from overseas or grow corn for ethanol, if it cared to fix a floor for the price of gas at, say, $3/gallon 50 years ago. So how about replacing cheap oil with one alternative, that for an extra price preserves all technical advantages of the oil itself? Namely, how about replacing cheap oil with a more expensive oil? The US imports more than a half of its petroleum, It also consumes twice as much oil per unit of GDP than Europe. What's the reason for such a dramatic difference in per unit consumption that accounts for the lion's share of the US petroleum imports? You don't really have to sweat very hard in order to figure it out - gas taxes in the US are only a fraction of what they are in Europe. This is not about making Americans pay more taxes, but about the fact that Americans are paying taxes in all the wrong places. Shift taxes to where they are due and you get that energy independence that right now appears so out of reach to MPM and others.


Top global petroleum consumers (red) and Producers (blue) in barrels per day.



PS

I stole this graph from here. It dates by 2008 and is really not meant to illustrate anything. It's included here only in order to keep you happy.


January 3, 2011

Fear the Boom and Low Prices

The place you should study isn't the bust
It's the boom that should make you feel leery



Now, to pass a judgment on the controversy between the two giants of modern economic theory is a bit out of my league. I can only say that my intuition is that both of them can be perfectly right at the same time and wrong at the same time. Certainly, most economists seemed to be in agreement during the crisis that some kind of stimulus was absolutely necessary to stop the economy from tanking. On the other hand, Hayek's idea of the bust as malinvestments driven by low interest rates should ring and ring and ring to a lot of people. The fact is that the two were concentrating on different stages of the cycle, but it's precisely here where I see a certain parallel between Hayek's focus on the boom part of the cycle and the energy market.

Hayek - Fear the Boom



Unlike food and cloths, the bulk of petroleum consumption does not happen because consumers are interested in drinking petroleum per se. The demand is conditioned by consumption of other durable goods such as cars and housing. Naturally, it makes the demand inelastic since, once a person purchases an SUV and builds a house in a suburb, he usually has no easy way to wind down his demand for transportation fuels. This makes consumption of such durable goods a bet on the long term performance of energy market. In this sense low energy prices, let alone subsidized prices, are not that different from low interest rates. This is just another factor that can easily confuse the market and trick consumers into overstretching themselves through malinvestments in these goods.

The oil market is neither very elastic on the supply side. The only cushion that this market normally has is the spare capacity of Saudi Arabia of which there's been left not so much recently. The Saudi manipulation of the oil market is basically an attempt to trade stability for the price, to moderately overcharge in exchange for a stable price secured through standby fields that Saudi can activate on-demand. It's hard to say that the Saudis were very successful in stabilizing the market recently. To sum it up, the lack of elasticity on both sides of the market, combined with frequent warnings about the approaching end of the age of cheap oil, should make any government think twice if it wants to have its citizens to continue growing petroleum addicted. The oil market has become too unreliable during the last few decades. You simply don't want to grow dependent on such a market, when you know that you may have no easy way to go back, when that proverbial thing hits the fan again.


In practical terms it means that governments should not worry so much about high oil prices. It's the boom part of the cycle that should make them feel leery. When the price is low, when people buy SUVs and other gas guzzlers, when the suburban sprawl is growing. This is because the trap of energy intensive economy is very easy to fall into. However, without a major technological breakthrough we are all still waiting for to happen, this trap can become very difficult to get out, if and when the oil market resumes exploring the world that lies beyond $100/barrel.


PS

Despite Keynes and Hayek representing two mutually hostile lines of economic thought, at least as far as Hayek is concerned, and there is a plenty of interviews with Hayek available on YouTube, there seems to have been no personal hostility between the two. In fact, it appears they were good buddies. That's why it's appropriate to end this post with a tribute to Keynes.


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