Energy subsidies

There is a good article in today’s New York Times that discusses fuel subsidies, particularly in Asia:

From Mexico to India to China, governments fearful of inflation and street protests are heavily subsidizing energy prices, particularly for diesel fuel. But the subsidies — estimated at $40 billion this year in China alone — are also removing much of the incentive to conserve fuel. …

China raised gasoline and diesel prices on June 21, though still keeping them below world levels. World oil prices plunged more than $4 a barrel within minutes on the expectation that Chinese demand would slow.

In Indonesia, the government spends six times as much on energy subsidies as it does on agricultural investments, even as rice prices have skyrocketed this year.

Many countries, like India, have raised oil prices considerably in recent months, only to watch world prices climb even further, pushing up the cost of subsidies once again. China’s estimated $40 billion in subsidies this year is up from $22 billion last year, mainly for this reason, although consumption has also risen, with Chinese buying 18 percent more cars in the first half of this year than in the period a year earlier.

A few comments:

1. It is reasonable to wonder how long many of these countries can afford these policies if oil prices stay around current levels.  (“Before adjusting the prices, Malaysia was spending 7.5 percent of its entire economic output on fuel subsidies, a greater share than any other nation. Indonesia follows with 4 percent.”)

2. The $40 billion figure for China is eye-popping, but it is not entirely clear what fuels it is for and how it was calculated.  The IEA has estimated that in 2005 China subsidized oil products to the tune of around $7 billion, out of $25 billion in total energy subsidies.  My understanding is that the 2008 World Energy Outlook is going to take another look at developing country energy subsidies.  I wait with curiosity.

3. As Free Exchange notes, a lot of the increase in oil consumption in China is being driven by increases in wealth and consumption more broadly.  Market prices won’t stop demand in China from growing but they might help prevent China from developing into an oil-addicted behemoth (see America, 1950s).

4. The EIA estimates that the U.S. currently subsidizes energy at around $16.6 billion, with about half of this going to renewables (particularly biofuels), nuclear power, conservation, and energy R&D.  About $2 billion goes to oil and natural gas, almost all in the form of tax expenditures.  On a per-unit basis energy is neither much subsidized nor taxed in the U.S.

Short run vs. long run

A brief anecdote:

Yesterday, I was spending time with a friend who lives in rural Maryland, and he mentioned that he’d just sent his resume out in DC looking for a job so he could move into the city. His reason? High gas prices. Driving around Montgomery County every day has simply become too pricey.

We discussed this as he filled up with $3.81/gal gas. It was fascinating seeing short run price inelasticity juxtaposed so immediately on long run price elasticity.

The real impact of gas prices

From the Washington Post:

In Kokomo, Ind., last week, Kathy Spier said the rising cost of gas is to blame for the 50 percent drop-off in sales at her three exotic lingerie stores. “They don’t have extra money to spend on frivolous things,” she said.

Categorical statement of the day

Not that I disagree, Tim:

The inevitability of spring. Flowers bloom. Thunderstorms roll. I sneeze. Gas prices rise. And politicians think they should do something about it.

“House Republican leaders on Tuesday challenged Speaker Nancy Pelosi (D-Calif.) to release a plan to lower gas prices that they say Democrats touted when they were in the minority.”

Instead of rewriting past posts, I’m going to just cut and paste my post from May 17 of last year below(one of my better, if I do say so myself). That post draws on the same ideas from a post in April/May 2006. Noticing a pattern? While the legislative proposals are different, the analysis is the same. All politicians are idiots.

This on the heels of John McCain’s gas tax holiday plan? To quote Charlie Brown, “AAAAARRRRRRGH!”

Update:  From Tim’s post, I think this is a superbly clear explanation of gas prices:

High gas prices might be uncomfortable while we search for viable long-term solutions, but they’re more comfortable than the alternative:  no gas and no solutions.

It’s summertime, and the gas is expensive

I’m becoming more and more interested in the actual processes involved in crude oil refining and fuel blending. Oil Drum has a nice rundown of truths and misconceptions about the summertime gas price spike. Especially solid is the explanation of the switch from winter to summer gasoline blends:

As gasoline evaporates, volatile organic compounds (VOC’s) enter the atmosphere and contribute to ozone formation. Gasoline’s propensity to evaporate is measured by Reid vapor pressure (RVP). In order to control VOC emissions, the Federal Clean Air Act Amendments of 1990 require that all gasoline be limited to an RVP maximum of 9.0 psi during the summer high ozone season, which the Environmental Protection Agency (EPA) established as running from June 1 to September 15. The Act also authorized the EPA to set more stringent standards for nonattainment areas. As a result, EPA limits areas designated as “high volatility non-attainment” to a maximum RVP of 7.8 psi during the high ozone season. Some States elected to require even more stringent restrictions to achieve local clean air goals, and require 7.2- and 7.0-psi gasolines.

Basically, since it’s hotter in the summer, you need a lower RVP to prevent your gasoline from vaporizing before combustion. As OD explains, winter blends incorporate butane as a blending agent, which is cheap but has an extremely high RVP rating; thus, summer blends face a higher marginal cost. In addition, the overall supply of gasoline bulges in the winter as the butane’s volume is added to the market. Of course, there is also the matter of increased demand during travel season.

However, I think the most economically interesting part of this regulation is the consequence of the variation from region to region:

More congested areas and hotter areas will tend to have a limit of 7.0 psig, while cooler climates generally opt for 7.8 psig. Some cooler climates don’t even require a reduction, and have a 9.0 psig limit throughout the summer…One of the disadvantages of having different requirements for different areas is that summer gasoline is less fungible. This can cause price imbalances in different areas, and sometimes prevents product from flowing from one area into another to ease the shortage.

I suspect that this helps explain why California summer gas prices always seem so out of control, even relative to the nationwide seasonal price increase.

Fun with statistics: the regressivity of gasoline taxes

Yesterday on Grist, Joseph Romm responded to a reader who argued that he should care more about incidence when talking about gas taxes. His response was a litany of citations suggesting that gas taxes were not in fact regressive, partially because the poor don’t own cars/ drive as much. Romm’s supporting evidence is pretty compelling. He cites a recent study by Don Fullerton (who used to be at RFF) which finds that a gas tax would only be regressive across the top half of the income distribution (BTW, Fullerton’s paper is one of the best I’ve seen on the public finance options for curbing vehicle emissions if you’re interested in that issue). Yet despite all of the evidence Romm put forth, I was still skeptical of his claim. I’m working on an incidence paper myself right now, and do see regressivity in the data. It just depends on how you define it. Below is a table with gas expenditure by income quintile from the 2007 BLS Consumer Expenditure Survey (which, btw, is the same source Fullerton uses):

Notice how different the story looks depending on whether you put income or consumption in the denominator. Both measures have their faults, and, in the policy world, people tend to flip back and forth between them depending what point is being made. Ideally economists would like to put lifetime income in the denominator, assuming that people incorporate their future welfare/ wealth into their current decision making (ie college student go into debt with the expectation that they’ll make much more money later on). For a more detailed discussion on defining incidence see this working paper by Gilbert Metcalf.

For those who don’t have time to check out the Fullerton paper, I’d also just like to point out something about the table Romm presented in his post.

However, he omitted the third column. To be fair, his point was about average effects across all people. Yet one can imagine how the second statistic might be relevant to policymakers. While poorer people are less likely to own cars/ drive, the ones that do are likely to be significantly impacted by an increase in the price of gasoline. If a household making under $20,000 a year does own a car, it’s probably because they live in an area where there aren’t any other options for getting to school, work, etc. This means that their demand response in the face of a price increase would probably be negligible, and a gas tax would simply crowd out other consumption. Thus you could imagine framing incidence in terms of rural vs. urban households, as well as simply rich vs. poor.

None of this is to say that one way is best. And I definitely support a gas tax, although I think we should be smart about implementing it. I just thought I’d point out that on this issue, like just about every other issue in DC, different people can use the same data to make different points.

Getting what you pay for: food & energy prices

In a relatively recent post, Rich asks how food and energy are different.  His implicit point (and I agree) is that in many ways they’re not that different.  My preliminary thoughts on why escalating food prices haven’t been getting as much press are: 1) oil is “sexy” in the sensationalist media sense of the term, food isn’t “sexy” until we start talking about riots and starving children, 2) the component of rising food prices that is related to rising energy prices suggests an inherent lag - energy prices are leading food prices, and 3) there may be some variation in the degree of regressivity in rising food prices versus rising gas prices.

I expand on number 3 and offer some other thoughts below…

Evan’s family is cleaning up

While the rest of us are being forced to DRINK LESS

From Greenwire:

Corn prices — already up 30 percent this year — yesterday jumped to a record $6 per bushel on the Chicago Board of Trade….Worldwide demand for corn to feed livestock and produce biofuels is putting enormous pressure on global supply, and with the U.S. planting less corn this year, the supply shortage will worsen….Corn growers are reaping record profits……

Couple things. First, why is that I can’t turn on the news without hearing, invariably in very tragic terms, about soaring gasoline prices, yet there is almost no coverage of soaring food prices? According the the BLS, American’s spend about 3X as much of their income on food as they do on gas.

Second, in light of the “record profits” being reaped by corn growers, how long until Ed Markey hauls these greedy farmers before Congress? Let’s just say I’m not gonna hold my breath. Until then though, anyone care to explain to me how these two commodities are different?

Suboptimal policymaking paragraph of the day

From the CBO Director’s Blog summary of a recent study on consumer responses to gasoline price increases. Not too much new here, but this paragraph caught my eye. Yet another example of how politicians’ categorical opposition to all taxes leads to poor policymaking and mixed incentives:

The study notes that the response of consumers to higher gasoline prices has important implications for policies that affect gasoline consumption, including CAFE (Corporate Average Fuel Economy) standards for cars and light trucks. Because higher gasoline prices increase the demand for vehicles with better fuel economy ratings, they reduce the economic costs (and fuel savings) of adopting more-stringent CAFE standards. At the same time, to the extent stricter CAFE standards improve fuel efficiency beyond what consumers would choose in the absence of such standards, they reduce the per-mile costs of driving — which would partially reverse some of the effects of higher gasoline prices discussed in this study. The federal tax on gasoline, by contrast, reinforces rather than neutralizes the behavioral and vehicle choice effects of higher gasoline prices. It also immediately affects all motorists’ incentives to reduce gasoline consumption, whereas CAFE standards primarily affect motorists only after they replace the vehicles they were driving at the time the standards were implemented.

Gas prices vs. wealth

Mark Perry argues that the economy can absorb current gas prices. Even though America has experienced increasing gas prices, the price of gas as a share of per-capita net worth is still lower than it was at any point except the early 1980′s and late 1990′s:

This an interesting way to think about the persistence of relatively inelastic demand, even as real oil prices near historic highs. However, Perry fails to consider that the average American lifestyle has changed considerably. According to the Nationwide Personal Transportation Study (as cited by Gordon, et al) , from 1985-2001 the average American’s commute increased from 8.5 to 12.1 miles, a 42 percent increase. Thinking about trends in land use over the past six decades, I would guess that these changes can be extrapolated to some extent through the time series shown in Perry’s graph, although I don’t have hard data that backs this claim. On the other hand, vehicles have also become considerably more fuel efficient since the 1950′s.

Although it does seem that the American economy is doing okay with higher gas prices, we clearly do not live in the 1950′s. Perry’s brief analysis proposes a way of scaling gas prices independent of consumption patterns, but we should be careful comparing the place of gasoline in today’s economy to its role in the immediate postwar era.

H/T: Mankiw.