riiiiiiiiiiiiiiiiiiiiiing! Okay, class. Eyes up front. Today's lesson: market-based economics. And those of you here for remedial studies, please pay attention, I'm getting sick of having to explain this time and again.
What prompted this was listening to the radio on the way to work and it was talking about how gas prices have gone up an average of 25 cents in the past couple of months. People are speculating that gas could hit $4.50 or even $5 a gallon by this summer. And people are saying that the problem is there is not enough supply for demand. We need to explore alternate energy sources and we need to expand drilling, most likely in the Gulf or Alaska, in order to bring prices down.
Wrong wrong WRONG!
Now, my stances on those issues is not the focus of this piece, and are, in fact, immaterial to what I want to explain (although, for the curious, here they are -- I support developing nuclear power. France has run mostly nukes for its power needs since the 1980's and they've never had a meltdown or an incident. If they can do it, I don't see any reason we can't. And I oppose drilling because, if we advance our nuke plants, there's no need for drilling). What I'm seeking to explain is how we could conserve gas and increase drilling and it won't make a lick of difference in the price of gas. Here we go.
Let's start with how you run a business. You are attempting to sell something to make a profit. You do this by selling for more than it cost you to make. It costs $X to make a copier, you sell it for $Y. Nothing to it, right?
Here's where things get dicey. A copier is a known quantity. You know exactly how much each component will cost, you know exactly how many of each component is available, you know where to get more if that supply runs out, there are tons of options to keep your costs low. But there are industries that do not have that luxury. Typically, they are at the mercy of nature. Coal mining. You don't know if that vein is going to dry up. Orange juice. The frost in Florida is ruining the yield. Precious metals. And, of course, petroleum.
Because of this, it is impossible to build a business plan around these industries. Numbers are based on certainty, and not knowing how long until that gusher goes out or if you are going to pop through a salt mine and drain the lake (type "Lake Peigneur" into your YouTube search and prepare to be amazed). And so, the futures market was born. The futures market works like this -- you run a business. This person has connections to whatever product you wish to acquire. So this person says he will sell you Z amount of whatever for $X on this specific date.
Now, that day, the person buys Z amount of whatever to sell to you, and you buy it for $X. Now, if the person paid more for the stuff than the $X you paid the person, the person loses money and you got a good deal and you make money. But if the person paid less than the $X you paid the person, you got a bad deal and the person makes money. Basically, it is everybody trying to outguess everyone else to see who makes the money.
Everybody with me so far? That's good!
Now, some things are resistant to these fluctuations. Orange juice usually sells at a consistent price regardless of what the futures are trading for (although that's going to change in the coming months). However, gas adjusts on the fly because so much of it is consumed, so the price adjustments happen faster.
So what does this mean? This means that the laws of supply and demand and other Adam Smith-ish bullshit don't apply here. It has nothing to do with what consumers are willing to spend, because there is an insulating market layer here. In fact, consumer gas consumption is still down, and prices are still going up. Why?
Because we live in a global economy.
Asia's gas consumption is going up again. When gas prices were hitting $4.50 a gallon, the problem was countries like China. The Chinese government subsidizes the cost of gas for its citizens. As a result, they only pay so much a gallon no matter what the price per barrel, the government takes care of the rest. As a result, futures traders could keep jacking the price up and knew they would still get the money because, even as consumption in the US fell, Asia (India is also a major consumer) made up the difference and they were willing to pay for it.
And so, if we increase drilling, we may increase the supply, but the supply is not being bought directly by consumers, enabling the price to go down. It still goes through the futures market first. The excess supply will simply increase the profit margin of the futures traders. Drilling and conservation affect nothing but the immediate surroundings.
This also means there is ultimately nothing we can do about prices. What started prices dropping last time was that China decided it had had enough and started passing the cost of gas on to its citizens. People balked about how much gas cost and demand went down. Futures traders could no longer sell stuff at those high prices and a lot of them lost fortunes (which made me smile, I admit). Now, prices are hovering around $3 out here, higher towards the city. Clearly, the increase is nothing we are doing. And eventually, the rubber band will snap back and the price will drop again. Just got to wait it out.
Now, alternate energy can help in the long run. Electric cars still need to be charged. If we phase out gas powered plants that charge the cars for nukes, that will be a good step in the right direction. Seeing more exploration about how natural gas is created (the research of maverick scientist Thomas Gold, for example) or liquified hydrogen is another good idea. But gas is still relatively cheap, it provides a powerful energy yield, and users are not disciplined -- they can gas up anytime and travel as far as they want, something they can't do without heavy planning with a vehicle that needs hours to charge.
In other words, forget about expanding drilling. And please don't pray to God to lower gas prices (THERE'S A WAR GOING ON, PEOPLE! IF YOU'RE GOING TO PRAY FOR DIVINE INTERVENTION, ASK FOR IT FOR THAT!). We either need to get really serious or simply accept that we're getting hosed. Gas hosed.