Saturday, September 03, 2005
There has been an odd dichotomy is the energy markets for the last couple of years. By all accounts, the available supply of crude oil has been consistently in excess of the demand, but the demand for gasoline has been nearly 100% of the supply. At first this seems to be a circular statement that makes no sense. That is until you realize that crude oil and gasoline are not the same commodity. The difference, of course, is that gasoline is refined. In essence, there has not so much been an oil shortage, as a refining shortage. Refineries are big and smelly and not welcomed in many areas of the country. The last refinery to be built in the US was the Garyville, Louisiana facility, which started up 29 years ago in the 1976. It was one of the eight refineries shut down by Hurricane Katrina, but reports say that it and three others will be back in operation by Monday. The huge Chevron refinery, which suffered a lot of damage, is said to be nearer to coming back on line than was originally thought. The release of oil from the Strategic Petroleum Reserve by the President was crucial in bringing some measure of stability to the oil markets. This is because many of he oil production platforms in the Gulf are adrift or damaged and may be months away from operation. Thus the crude released by the President gives vital feedstock to the refineries, which the experts say have been damaged but are mainly awaiting power to come back online. In addition, the International Energy Association is releasing 2 million barrels of crude oil per day to the US. These two sources of crude oil pushed crude oil prices down by nearly $2 on Friday to approximately $67.50. I am not as worried about the energy situation in the short run as are many analysts. My reason for modest optimism is something called the elasticity of demand. This is a very basic concept in economics that says as prices rise, demand slows. Many of the commentators that you hear spouting about oil prices going through the roof believe that oil consumption is inelastic. That is, oil consumption is not responsive to price. History would appear to be on their side because oil consumption has, indeed, risen over the years, even in the face of rising prices. Where I differ from these commentators is that it has been my observation that things change during crises. Crises make people stop and think. You might say tough times make people count the costs. With gasoline prices at $3.40 per gallon and the horrors of Katrina fresh in our minds, in my judgment, prices will bite and oil consumption will begin to moderate. I want to keep reminding you of what happened the last time we had an oil crisis that actually reached the consciousness of the American people. That was in 1979 during the Iranian revolution. The Shah of Iran had fled the country and the radical Islamic Ayatollah Khomeini and his followers seized power. They may have known something about revolution, but they knew nothing about oil production, and Iranian oil production collapsed, causing oil prices to skyrocket world wide. Because American's saw prices explode and realized supplies were likely to be uncertain for a long time, they began a conservation and substitution campaign that was utterly remarkable. In 1979 the US imported 32 million barrels/day of oil from OPEC. Three years later that figure had fallen to 19 million barrels/day. I don't foresee a pullback in consumption of that level, but I believe Americans will begin to become more conscious of their gasoline consumption and in doing so their consumption will slow. This sounds like a bold statement without much to back it up, but I have observed time and again that when events appear to be spiraling out of control, people will almost always insert their own attempt to control events. There is only one thing they can do: cut back on consumption, and I think that is what they will do. I still believe the economy will dip between now and the beginning of the year, but I completely disagree with those people who are calling for a recession. In my mind, that would be almost an impossibility. Prior to Katrina, most estimates had GDP growth above 4% for the third and fourth quarters. I do not believe it is possible to shut down an $11 trillion economy so fast as to push us into recession. I expect the economy will be accelerating by the early part of 2006. The rebuilding of the Delta region will be a massive stimulus to the economy for the foreseeable future. I admit that my view of the unfolding events is optimistic. I think you also know that my attitude is that most people overestimate the negative effects of natural disasters. My experience tells me as bad as things may seem, repairs will be made, the lights will come on, the water will leave New Orleans and a rebuilding process will begin. The only obstacle I can see that would slow the coming economic stimulus is if a debate breaks out about the wisdom of rebuilding a city that lies below sea level. I am hearing some rumblings of this. If it becomes widespread, the rebuilding may be delayed until next spring. If that were to happen, the economy will slow after the first of the year. I'll have more comments in the days ahead.