$12 – $15 gas? Not so fast. But we’ll soon be mad for $6 – $7

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"$12 – $15 gas? Not so fast. But we’ll soon be mad for $6 – $7"

mad_money.jpgNormally I would listen to Robert Hirsch and the legendary Charlie Maxwell, over CNBC’s “Mad” Jim Cramer. But Hirsch (here) and Maxwell (here) are making headlines for saying $12-$15 gasoline is around the corner, based on Maxwell’s projection of oil “reaching $180 a barrel in 2015 and $300 a barrel in 2020.”

Sorry guys, every extra $40 barrel is another dollar a gallon or so at the pump. Don’t quite know how they did the math, but they did it wrong.

When Mad Money‘s Jim Cramer is the voice of sanity, you know the energy world is topsy-turvy, but I happened to catch him explaining to Matt Lauer on Today that such prices take us to $6 to $7 over the next few years, yes, but $12 to $15 gasoline requires a price of oil that the world is exceedingly unlikely to get to any time soon — $450 to $500 a barrel by my estimate. The world would almost certainly go into a deep global recession long before we hit those prices.

But the situation is dire, as I’ve noted many times (see below). The WSJ has a front page article today, “Energy Watchdog Warns Of Oil-Production Crunch: IEA Official Says Supplies May Plateau Below Expected Demand,” which begins ominously

The world’s premier energy monitor is preparing a sharp downward revision of its oil-supply forecast, a shift that reflects deepening pessimism over whether oil companies can keep abreast of booming demand….

For several years, the IEA has predicted that supplies of crude and other liquid fuels will arc gently upward to keep pace with rising demand, topping 116 million barrels a day [MMBD] by 2030, up from around 87 million barrels a day currently. Now, the agency is worried that aging oil fields and diminished investment mean that companies could struggle to surpass 100 million barrels a day over the next two decades.

But we’ve been rising maybe 2% a year, so we were poised to run into 100 MMBD by around 2020. IEA isn’t alone in its concern, as I noted in my recent article on peak oil:

In October, Christophe de Margerie, CEO of French oil company Total S.A., said that production of even 100 million barrels a day by 2030 will be “difficult.” In November, James Mulva, CEO of ConocoPhillips, the third biggest U.S. oil company, told a Wall Street conference: “I don’t think we are going to see the supply going over 100 million barrels a day … Where is all that going to come from?”

While $12 to $15 a gallon gas is probably a long way away — and still preventable — it looks increasingly like we dawdled too long on alternatives to avoid $6 to $7.

This problem cannot be solved rapidly, a point Hirsch made in “Peaking of World Oil Production,” a terrific and widely-cited study funded by the Department of Energy in 2005 — yes, the Bush DOE — which concluded:

The world has never faced a problem like this. Without massive mitigation more than a decade before the fact, the problem will be pervasive and will not be temporary. Previous energy transitions (wood to coal and coal to oil) were gradual and evolutionary; oil peaking will be abrupt and revolutionary.

But if we are to avoid $12 gas, the next president must begin a rapid transition to advanced hybrids, especially plug-ins.

[You can read the thoughts of Jerome a Paris here.]

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26 Responses to $12 – $15 gas? Not so fast. But we’ll soon be mad for $6 – $7

  1. Earl Killian says:

    If you want to predict gasoline prices, I think you need to seriously study its elasticity. Gasoline prices will rise to the point where demand is destroyed to match production. This will happen first by pricing the poorest out of any consumption, and reducing the consumption of the next poorest. The question is what price will do that. In the U.S. the price will increase until drivers switch to efficient vehicles, but new vehicle purchases take a long time to effect the fleet.

  2. Lou Grinzo says:

    Joe,

    While I agree with your conclusions about various gasoline price predictions, let me toss in one other point here: The price of gasoline is influenced by more than just the price of oil. A heuristic like $40/barrel oil change = $1/gallon gasoline change assumes that there is no production bottleneck at the refinery stage. To pick a perverse and near-zero-probability example, if terrorists blew up or disabled several large refineries, we would see the price of gasoline skyrocket and a huge gap open up between the prices of oil and gasoline.

    I think the forthcoming IEA report you mentioned will be seen as a landmark event in energy economics. I wrote about this reshaping of the energy landscape this morning on my site:
    http://www.grinzo.com/energy/index.php/2008/05/22/deciphering-the-oil-market/

  3. Greg N says:

    “If you want to predict gasoline prices, I think you need to seriously study its elasticity.”

    Yes – but the usual economics of elasticity don’t apply.

    On a road near you, some drivers already pay twice as much for gas as a driver in the next car. Not twice as much in terms of gas per gallon, of course, but in terms of cost per mile.

    That’s where the confusion on this topical always lies. People are too used to thinking of cost per gallon, which is entirely the wrong measure. Always think in terms of cost per mile if you want to consider the economics!

    And when you look at cost per mile, the economics gets seriously weird. Some drivers choose to pay twice as much per mile! What’s more, these driver spend more upfront on their vehicle in order to pay twice as much per mile. Just compare the relatively high cost of a new gas-guzzling SUV with the relatively low cost of a new efficient car…

    Conventional economics simply can’t cope with a situation where some people voluntarily choose to pay more per mile to get from A to B. Conventional economics starts with the premise that economic agents are rational and profit-maximizing. But when it comes to cars we humans tend to act silly.

    An alternative way to look at it: imagine a country where all cars achieve 30 mpg. But at filling stations there are two sets of pumps – one side of the station charges $3 a gallon and the other side charges $6 a gallon. Some drivers voluntarily choose the $6 a gallon pumps. Why? Economics can’t answer (the answer lies in psychology and status symbols and theories about conspicuous consumption giving more personal reward than private consumption). This situation mirrors reality – everytime I fill up at my pump I know I am paying half the price (per mile, not per gallon) compared to the person in an enormous SUV at the next pump along.

    The problem isn’t that new purchases of efficient vehicles take a long time to effect the fleet. The problem is that millions of humans around the world are deliberately choosing inefficient vehicles – even though they are fully aware of the high cost of motoring that they’ll pay as a result.

  4. Joe,

    As much as it is important to create incentives for consumers and businesses to transition to a more efficient fleet, this transition will take quite a bit of time.

    Why don’t you talk as much about decreasing miles traveled? Is it less politically feasible? Does it take more time to address that? Is it more expensive?

    It would be interesting to see what changes to housing codes and tax laws need to happen to repopulate cities and reduce sprawl, could provide a little bit of a break from energy policy.

  5. Uosdwis says:

    It’s official. 12:01 EST, May 22, 2008, CNBC pronounces “Oil has peaked!”

  6. paulm says:

    Of course James Hansen knew all along that oil had peaked. That is why he specifically addresses coal use reduction!

    For a carbon tax on gas – what should that be now that the markets are doing such a good job at pricing oil out?

    Of course there is going to be much higher prices and chaos as countries panic and terrorist incidents increase. Kind of a (positive) feedback.

  7. Joe says:

    Tommaso — it is a very good question that I actually intend to blog on next week. Fundamentally, over the period of the next two decades say, reductions in VMT are unlikely to come about because of policy measures — but they could come about as a result of behavior change driven by higher gasoline prices.

    I have always had doubts about legislating reductions in VMT. But the Congress could certainly take a variety of steps that would make it easier for people to reduce VMT as prices drove them to do so.

  8. Greg N says:

    “For a carbon tax on gas – what should that be now that the markets are doing such a good job at pricing oil out?”

    The markets can’t do anything like as good a job as taxes. In the UK and most of the European Union the price is $8.25 a gallon, showing what can be reached with a tough tax policy.

  9. charlie says:

    Or, mandate all new cars have little gauges that give various MPG readings (current, over a trip, since last fill-up). Gotta look to the margins to see where gas usage drops.

    Also, if all our old SUVs are being sold to Mexico, that is not really helping anyone.

  10. Greg N says:

    “Fundamentally, over the period of the next two decades say, reductions in VMT are unlikely to come about because of policy measures — but they could come about as a result of behavior change driven by higher gasoline prices.”

    You seriously think higher gas prices will significantly reduce miles driven?

    In the UK we’ve had just that – relentless rise in gas prices over the past 20 years, due to higher and higher taxes. Has the CO2 emissions from vehicles fallen over this time?

    No.

    Admittedly the UK’s average miles driven p.a. has fallen slightly in the past decade (by 8%), and the mpg efficiency has improved as well (by 10% for new cars purchased) – but there are more cars on the road to counteract these improvements.

    The impact of price on motoring behaviour simply isn’t enough.

  11. Joe says:

    Greg — Well, US VMT/capita is 50% higher than UK VMT/capita.
    I’m actually quite certain that higher gas prices will significantly reduce VMT. They already have!

  12. Greg N says:

    Are you sure? The stats I’ve seen show VMT rising in step with the rise in GDP

  13. David B. Benson says:

    VMT?

  14. tidal says:

    Uosdwis Says:
    It’s official. 12:01 EST, May 22, 2008, CNBC pronounces “Oil has peaked!”

    Thank God that’s over! Whew!

  15. steve shoap says:

    Low car weight (or mass) is the most important requirement for improvement in fuel economy. An electric car, a hybrid car, or a hydrogen car will be more fuel efficient if they are lighter. Light weight is dangerous in collisions unless crumple zones for the rear and side of a vehicle are provided.
    I have invented a way to make small cars much safer in collisions.
    Please see my website safersmallcars.com
    If you like the idea, please tell the car companies who have rejected my idea.

  16. Robert says:

    Joe

    “$450 to $500 a barrel by my estimate. The world would almost certainly go into a deep global recession long before we hit those prices.”

    If the price trend since 1998 continues (a doubling every 18 months) we will hit these prices by the end of 2010. http://www.freecharts.com/Commodities.aspx?sym=CLY0&data=H&page=chart

    Global recession is not guranteed in the way that it was in the 70’s. The current growth in prices is due to strong global growth vs limited supply and high prices simply reflect the high marginal value of the commodity.

    Swithching to more efficient vehicles is a natural response but won’t (a) lessen global demand, (b) reduce prices or (c) cut global CO2 emissions. These are dictated by supply-side capacity only.

  17. Andy Bauer says:

    David,

    VMT = Vehicle Miles Traveled.

    Personally, to save money, reduce CO2 and just get a chance to work out more often, I would love to see more buses and trains with bike racks.

  18. Earl Killian says:

    Joe and Tommaso, California’s regulatory agencies are starting to look for policies that can affect VMT. I don’t know if they will succeed or not.

    David, VMT = Vehicle Miles Traveled. VMT in the U.S. in 2006 was 2.7 trillion miles (about 10% of the way to Alpha Centuri). That was approximately 9300 vehicle miles per capita. VMT has been growing faster than population, which is not a good sign.

  19. Earl Killian says:

    Greg N, I think part of the problem is that for some people their gasoline bills are well below their disposable income. Some people spend more per day at Starbucks than they do on gasoline. In this situation people prioritize things like status and comfort above expense. That’s why I wrote that demand destruction will likely come from the poorest and next poorest of current drivers (and also by preventing others from entering the driving class). It certainly won’t affect those that spend more on coffee and bottled water than they do on gasoline.

  20. Earl Killian says:

    Lou Grinzo, I think that’s a good observation. It seems that the oil companies have stopped building new refineries or adding much capacity to old ones and that refineries are as limiting as crude is. The oil companies know that there is no reason to spend the money if peak oil is due within the payback time of their investment.

  21. Greg N says:

    Earl Killian, I agree that most of us are so wealthy (by historic/global standards) that we can afford to spend huge amounts on gas.

    The thing is, GDP per capita is also rising steadily, bar the odd recession every now and again. We get richer, standards of living rise, disposable income goes up and up.

    So the demand destruction doesn’t happen – the price of gas goes up, but disposable income also goes up. More people can afford cars each year, and people can afford to drive more miles.

    High prices are a component in a strategy to reduce gasoline burning, but they aren’t anywhere near enough.

  22. Robert says:

    Greg N

    “High prices are a component in a strategy to reduce gasoline burning, but they aren’t anywhere near enough.”

    There are 3 variables: supply, demand and price. Supply is fixed in the short term (and arguably “peaked”) and always equals demand. Therefore the only variable which can adjust is price.

    Price will move to whatever level it needs to to ensure that supply = demand. If that means $1000 / barrel then tough. Free markets are at the core of the American culture so its a bit late to complain.

  23. Greg N says:

    Price isn’t the only variable – if you are prepared to move away from free markets.

    E.g. regulation becomes a variable, or petrol rationing could be a variable, or outright bans of certain vehicles.

    Any market can be distorted anyway you like, if a government can get it through politically

  24. David B. Benson says:

    Andy Bauer — Thanks.

    Me too.

  25. John Mashey says:

    It’s worth looking at this slightly old EERE chart of use of oil in transport.

    Not all oil in the US goes to passenger use, of which at least some is pretty elastic.
    Much goes to trucking, railroads, airplanes, off-road (including farming). In that chart, the category “light trucks” is awkward, because some are used for business, some are real trucks used partly for business and partly for passenger transport, and some are misnomered passneger vehicles.

    Faced with higher diesel fuel prices a farmer does not say “Well, I think I won’t harvest my wheat, I’ll defer that”, and truckers either figure out how to raise prices, or go out of business. The military looks to gets its budget raised. Airlines charge per bag, and do whatever else they can. I.e., there is some elasticity … but what really happens is:

    higher fuel prices =>
    people who can pass along higher prices do
    those who can’t have to provide the elasticity to reduce usage

    So, in practice, for a consumer, it *isn’t* just an incrased priice the pump, which everyone follows, because it’s so visible, it’s that plus the embedded price rises in:

    – food [fertilizer (natural gas), off-road farm vehicles, class 8 grain trucks, railroads, other trucks)]
    – transport of other non-good goods
    – water (in some places, like CA, where 20% of our electricity used to pump water, and at least some of that comes from natural gas)

    As per Hirsch, vehicle fleet changeovers take a long time, and yield stranded assets (like SUVs that no one will take in tradein).

    Can people point to any good studies that quantify the economic impact on consumers, not of the (easy) price at the pump and VMT, but of the cost of higher fuel prices embedded everywhere else?

  26. David B. Benson says:

    Here is a very fine review of Peak Oil and Peak Coal by David Rutledge (which is a bit older, but I missed it first time around):

    “The Coal Question and Climate Change”

    http://www.theoildrum.com/node/2697