Perry Management, Inc.

So What Has Happened to Our "Cheap" Gasoline?
by Charles R. Perry
Perry Management, Inc.
copyright © 2005 Perry Management, Inc.

NATURAL DISASTERS MAY TRIGGER WHAT WAS COMING ANYWAY:

Although some may feel that Katrina and Rita caused all the trouble in oil refining capacity, the United States has been on the ragged edge of running short of capacity for more than five years (see: Oil Crisis? How About the Refinery Crisis?, and many other papers describing the problems in expanding our refining industry).  In spite of many older and smaller refineries being closed, the industry has managed to keep its total capacity up by a band-aid approach of “debottlenecking.”  Another problem is that the world demand for crude oil is rising rapidly while world oil production is not.  The worldwide outlook for crude oil will be the subject of a future article.

A LESSON IN ECONOMICS 101:

So as always happens in a free economy, a shortage of supply has caused the price to rise rapidly, (just as a surplus in supply would have caused the price to fall.)  In a true free economy, there is never a shortage of supply – prices rise and demand falls until supply equals demand.  Preliminary indications are that with the run up in gasoline prices after Katrina,  (which caused about 12% of the U.S. refining capacity to be shut down at least temporarily), conservation has kicked in, and we are now using less gas.

Then along comes Rita, and supposedly there is already a short supply of gasoline.

With Rita, we saw another 22% of the refinery capacity shut down temporarily.  But other than spot shortages along the evacuation routes for Rita, we still have not seen any gasoline shortages in the U.S.  Now, 2 days after Rita hit, there is plentiful gasoline all over the country with only a few reports of tight supplies.

Inventory reports as of September 20 indicated gasoline inventories had risen an amazing 3.4 million barrels for the week ending September 19.  Inventories of gasoline had also risen the two previous weeks.  In fact, demand has declined to a point where we have actually encountered no widespread shortages of gas anywhere in the U.S., in spite of the loss of about 1.5 million barrels per day in refining capacity

So let’s face reality: the only way the American people will conserve gasoline is if the price is high enough to cause them to cut out unnecessary trips, to acquire more fuel efficient vehicles, to form car pools, and to use mass transportation.  This was proven back in the ‘70’s when disastrous price controls were implemented by the Federal Government to keep gasoline prices low.  With low costs for fuel, there were no significant efforts by drivers to conserve, and we quickly ran out of gasoline.  Do you remember having to go to several stations and if you were lucky, you might find one with gasoline for sale.  Politicians seem to have the impression that every American is entitled to life, liberty, the pursuit of happiness, and cheap gasoline for their SUV’s.

THE RELATIONSHIP OF PRICE AND DEMAND:

Data from the developed countries dramatically show that gasoline consumption per capita is directly related to the price the consumer pays for gas.  (See Figure 1 and Table 1.)  Of course everyone says that is to be expected, but one look at Figure 1 shows how dramatic this relationship is.  European countries and Japan have for years maintained high gasoline prices with taxes on fuel.  This was done primarily due to the fact that these countries had little production of oil within their countries, and they needed to minimize the cost of oil imports.  The U.S. consumption has been running about 450 gallons of gasoline per capita per year, but other developed countries consume only 100 to 200 gallons of gasoline per capita per year – or less than half of what the U.S. consumes.  It would be overly optimistic to expect the U.S. to match these consumption figures, but certainly 350, or maybe even 300 gallons per person per year should be achievable.   Figure 1 indicates that with $3 plus gasoline, the U.S. per capita demand will fall to about 300 gallons per year – a 33.3% reduction which will occur in time, after everyone takes steps to reduce their use of gasoline, and the U.S. has time to develop more mass transit.  With high fuel costs for many years, these other developed countries have developed efficient mass transportation, and it has been heavily utilized because it is much more economical than driving one’s car.  So it is reasonable to expect that over a period of time, mass transit systems in the U.S. would be much more fully developed if gasoline prices remain high.

Country	March 2005 Gasoline Price/Gal U.S. $	Annual Gasoline Consumption MM Gals	Population MM People	Gasoline Consumption Gallons per Capita
United States	2.18	133,050	295.73	450
Switzerland	4.74	1,331	7.49	178
Sweden	5.8	1,434	9	159
Denmark	5.93	682	4.43	154
Norway	6.27	584	4.59	127
Japan	4.24	15,461	127.4	121
United Kingdom	5.79	7,190	60.44	119
Germany	5.57	9,537	82.43	116
Italy	5.96	5,769	58.1	99
Netherlands	6.48	1,462	16.41	89
France	5.54	4,535	60.66	75
Belgium	5.91	732	10.36	71

Sources:
CNN/Money: Gasoline Price/Gal  U.S.$
California Energy Commission: Gasoline Consumption MM Gals.              
Click Z Networks: Population  MM People  

WHAT IS THE CAUSE, AND WHERE WILL IT END?

Now, let’s get back to the root of the problem.  World demand for crude oil is growing rapidly, with much of the growth in Asia, primarily in China and India.  At the same time, the vast majority of our oil worldwide is produced from old “Giant” fields.  These fields are now mature, and some have begun to decline.  It even appears that Saudi Arabia production is at, or near its peak production (see Twilight in the Desert, by Matthew R. Simmons.)  While new oil is being discovered, it is in smaller fields, sometimes remote, and it takes many of the new, smaller fields to replace one of the old “Giants.”

So what this means is we are running out of oil worldwide, and we have already run out of cheap oil.  But this does not mean that we will have oil one day and it will all be gone the next day.  Instead, the amount of oil produced in the world will plateau, and then slowly decrease.  As this occurs, the price will rise until the demand starts to decrease.  (Remember in a true economy, the price of a commodity will increase and/or decrease until demand and supply are equal.)

WHAT ABOUT ALTERNATIVES?

Much has been said about alternate fuels, particularly by politicians.  Ethanol, biomass fuels, and maybe even hydrogen are potential alternate fuels, (and certainly should be developed wherever possible – before this is over, we will need every source of energy available to us.)   These alternate fuels are expensive to make, and they become attractive economically when gasoline prices are high.  However, they never can be made in quantities sufficient to replace the gasoline we use today, and will always be supplemental to our main energy supply.  For someone to expect these alternate fuels to eventually replace gasoline, they are simply daydreaming.

Another potential source of a type of crude oil is shale oil.  The U.S. reportedly has more shale oil reserves than Saudi Arabia has crude oil reserves.  But shale oil requires huge capital investments, and will take many years to bring it into production.  Once that is done, we will have another source of high cost oil.

THE BOTTOM LINE:

When you put all of these factors together, one can readily realize that the days of low cost gasoline are over.  We Americans need to bite the bullet, and start rearranging our lives and our infrastructure to be able to live with, and make our economy progress with, high cost gasoline.  The sooner we get started, the sooner we can get our lives adjusted.


Charles R. Perry is President and CEO of Perry Management, Inc., a consulting firm in Midland, TX.  He is a Registered Professional Chemical Engineer in Texas, and has had over 50 years experience in the oil, gas, and electric power industries.  He is the holder of numerous patents, and the author of many technical papers, and his background includes both top management and technical development in energy businesses.