“The EOR (Enhanced Oil Recovery) tax credit has served the country well by encouraging the development of expensive oil reserves when prices would make them uneconomic.”
Posted by Evan Herrnstadt on May 22, 2009
“The EOR (Enhanced Oil Recovery) tax credit has served the country well by encouraging the development of expensive oil reserves when prices would make them uneconomic.”
Posted by Daniel Hall on December 30, 2008
There has been a bit of discussion in the comments to my previous oil post about the role speculation played in both the rapid rise and spectacular collapse in oil prices over the last 12 months. Commenter Dave Sawyer sums up the idea:
What about good old speculation? Seems that with the demand growth and price rise, hot money flowed in and further drove up prices. With the credit collapse, and all the associated margin calls, the same then became true in reverse. A demand destruction and speculation downward spiral.
I am reflexively skeptical about arguments that use speculation to explain a large portion of price movements. Liquidity can probably help push up prices a bit but positing large price increases from ‘hot money’ seems to be an argument that extra liquidity is will primarily encourage investors who are long oil but that same liquidity will do little to encourage other investors to take the opposite bet. I like these thoughts from Geoff Styles when he sums up the “Energy Lessons of 2008“:
- Demand matters as much as supply in determining prices. The difference between oil at $145 per barrel and $40 is only a couple of percent of global demand, or more precisely a swing between steady growth of 1-2% per year and a shrinkage of similar magnitude.
- Speculation can amplify prices and market volatility, but it can’t override a dramatic shift in the underlying fundamentals of supply or demand. Leverage increases not only the magnitude of speculative gains and losses, but apparently also the speed of the shift from one state to the other.
Think about that final sentence!
The one additional point I would make is that even if speculation can push up prices a bit in the oil market, the oil that is consumed is actually worth the money that is paid for it. Even when oil was $145 a barrel, every barrel that was consumed — all 85 million a day of them — was worth at least $145 to the person that was buying it. That doesn’t mean that oil is worth that much in the long-run — I suspect we are going to see a long-term demand shift in the West that will be comparable to the demand shift that followed the 1970s oil crisis — but in the short-run oil is very, very valuable to those who need it.
Posted by Daniel Hall on December 19, 2008
The pithy answer is nothing — not production, not consumption, and certainly not the price.
I have heard some head-scratching and shoulder-shrugging about the recent behavior of the oil market. (Yes, you have to listen closely to hear those things.) In the last year we’ve had:
Whiskey. Tango. Foxtrot.
My short answer — and I would be only too happy to receive corrections or alternate theories from more educated readers in the comments — comprises 3 factors:
1) The price rise was demand-led; the current collapse is demand-led as well. It turns out that even in car-loving America you can get a nice bit of short-term (and perhaps long-term) demand destruction with $4 per gallon gas.
2) Oil futures are not tremendously influenced by OPEC’s announced cuts. OPEC does not have a great track record for maintaining cartel discipline when the market is loose. Too many of the small countries oversell their quotes, and the budgetary pressure on some of these governments — who spent the last year making all their plans with $80-140 barrel per oil in mind — will be intense.
3) The most important factor in oil futures right now is not the OPEC announcement but expectations about future economic conditions. And in this sense the oil future prices we are seeing right now are terrifying. America is going to remain in recession in 2009 and demand will be weak, but you would think that even moderate economic growth in China would be enough to buoy the oil market. I find the fact that futures are down so far to be extremely worrying.
By the way, here is a fascinating map that depicts where US oil imports come from.
Posted by Daniel Hall on December 18, 2008
China cut fuel prices for the first time in almost two years after crude oil slumped, seeking to reduce costs for companies and factories as the economy enters its deepest slowdown in almost two decades. The ex-factory price of gasoline was lowered by 14 percent to 5,580 yuan ($816) a metric ton, diesel by 18 percent to 4,970 yuan and jet fuel by 32 percent to 5,050 yuan.
The cuts look consistent with a policy which is more focused on industrial support than strictly subsidies for end users (note the larger decreases for jet and diesel fuel). Also, at the same time:
A plan to increase fuel consumption taxes was also approved, the commission said. The gasoline consumption tax will rise to 1 yuan a liter from 0.2 yuan and the levy on diesel will climb to 0.8 yuan from 0.1 yuan. Taxes on other fuel products will increase too, the commission said without giving details. The government is raising fuel consumption taxes to replace road maintenance fees to encourage energy conservation.
Here is the source. This mix of wholesale fuel subsidies combined with end-use taxes seems to me to scream, “black market in fuels!”
Is China leading or following with this policy? The same article concludes:
Vietnam reduced gasoline prices four times in October to curb inflation. Malaysia has cut fuel costs five times since June. Indonesia may lower gasoline prices next month.
Oy. Not good.
Posted by Daniel Hall on December 18, 2008
Joe Weisenthal calls for a ban on shorting oil:
Oil delivered a year from now is selling for so much more than oil is today, that traders are actually buying oil, renting out barges, and then just storing it for a year so they can make a profit. In a rational market, this shouldn’t work. …
Now look, look, don’t get us wrong… we’re all for free markets here. In normal times, the market is the best way to set prices. But in extreme times when the market stops behaving orderly and the prices make no sense, the government must, unfortunately, intervene. The first step is a ban, or at least an uptick rule, on shorting oil.
Count me skeptical that shorting holds much of the blame for the plunge in oil prices. Remember that when both supply and demand for a good is highly inelastic, small shifts in either can produce very large swings in the price. Global demand for oil has certainly shrunk, both in response to the high prices from earlier this year, and now also because of economic recession. Demand was the major reason prices skyrocketed earlier this year, and I suspect demand is now the major reason prices have plunged.
Commodities which cannot be stored are particularly susceptible to these big price swings — think of electricity, where supply and demand must essentially balance in real time, and hence the marginal price of wholesale electricity will fluctuate wildly in a single day. Certainly oil can be stored more easily than electricity, but not as easily as many commodities (particularly compared to the volume of global consumption). And oil is a commodity which can be extremely valuable, right up to the point where you don’t need anymore, at which point the next bit of oil is nearly worthless to you. Just because oil will be worth $60 (or $100, or $200!) per barrel to you next year does not mean that right now it is worth it for you to personally acquire an additional barrel of oil for less than $40 — unless you can cheaply store that extra barrel.
And on that storage question, Geoffrey Styles, while looking at contango in the oil market, suggested last week that general economic conditions may be making storage hard to come by:
At yesterday’s settlement on the New York Mercantile Exchange, oil for delivery in February carried a $2.59/bbl premium over January, and March was another $2.20/bbl higher. Oil for delivery in December 2009 was a whopping $13.81/bbl higher than the January ’09 futures. The fact that sufficient oil is not being bought today and put into storage for future delivery to close the arbitrage opportunity this situation creates is a clear indication of just how tight commercial credit has become, recently. As it is, US oil inventories have climbed by 26 million barrels since the end of September, rising from close to the bottom of their seasonally-adjusted range to near the top. [emphasis added]
In other words, the storage that is out there is filling up, and right now it is damn hard to come by funds to finance new storage.
Update: Geoff Styles comments further at the Energy Collective:
Liam Denning of the Wall St. Journal looked at this in this morning’s “Heard on the Street” column: http://online.wsj.com/article/SB122953721352814785.html He incorporated the floating storage (oil on leased tankers) aspect that I had missed the other day.
I’d suggest thta Mr. Weisenthal has his facts, or at least his perspective on the facts, exactly backwards. The price for long-dated oil futures isn’t so much higher than the front month because traders are driving it up by taking oil off the market. Instead, the super-contango suggests that there is such a glut of oil today that it is driving down the price to the point that it pays traders to buy and hold oil in spite of extraordinarily high interest rates. (If interest rates were lower and credit more available, I’d argue that oil prices would be higher, because the bidding to buy oil for this “carry” play would be more intense, and the price would rise until the arbitrage closed.) He’s also wrong that this reflects a market that has stopped “behaving orderly.” Buying and holding when contango appears is a standard trading strategy. We normally don’t see such a severe contango, because when credit is cheap, the arbitrage is so easy to do.
If this practice were banned, as Mr. Weisenthal suggests, the near-term glut would worsen, causing cargoes to pile up at refineries, crude prices to drop further–perhaps to the point it stimulated demand, even in this weak economy–and more oil wells to shut in, some at a cost to long-term resource recovery. That would only worsen the potential for an even bigger price spike, once the economy recovers.
Posted by Rich Sweeney on October 30, 2008
Sarah Palin went to a solar plant in Ohio to talk about oil today.
We shouldn’t doubt the Governor in this department though. She gets her energy policy advice directly from God.
Posted by Daniel Hall on October 16, 2008
We can eliminate our dependence on foreign oil…
I’d note that both campaigns have been peddling this rubbish pushing this rhetoric. Windmills and biofuels are no more likely to accomplish this than nuclear reactors, at least not on any timescale that is relevant to this election.
Posted by Evan Herrnstadt on September 16, 2008
Posted by Daniel Hall on September 5, 2008
If we are going to have an emergency stockpile, it really ought to be able to function during an emergency.
Posted by Evan Herrnstadt on August 8, 2008
From Krugman in the Times:
According to one recent poll, 69 percent of Americans now favor expanded offshore drilling — and 51 percent of them believe that removing restrictions on drilling would reduce gas prices within a year.
Posted by Daniel Hall on August 6, 2008
1. Someone asks a question.
2. Tyler Cowen offers a response that is correct but that doesn’t seem to (directly) address the question.
3. Lynne Kiesling offers a response that (probably) addresses the question but doesn’t seem to be correct.
Posted by Daniel Hall on July 29, 2008
At a time when we’re facing $4 gasoline, I think that you need people who’ve been in the energy industry to tell us what to do.
—Steve Pearce, a House member from New Mexico who is running for the Senate
With retail gasoline prices in the US persistently above $4 per gallon, the determinants of gasoline prices is no longer an esoteric topic best left to industry insiders.
—Lutz Kilian, Associate Professor at the Department of Economics, University of Michigan and a Research Fellow at CEPR
I think I am going to throw my lot in with the economics professor. Kilian’s post over at VoxEU discusses why U.S. gasoline prices have risen in recent years. (Hint: it’s not the speculators.) Kilian also postulates that high prices are here to stay and says that the best predictor of future prices is today’s price.
H/T: Kevin Drum, with a very trenchant response to Pearce’s quote.
Posted by Daniel Hall on July 28, 2008
I have been wondering when this was going to happen — with oil prices this high and a decided shift in rhetoric coming from ‘official’ venues such as the IEA about long-term supply, it seemed like it could only be a matter of time before someone would construct a coal-to-liquids (CTL) plant.
Coal is abundant and still relatively cheap (despite recent price increases). And the article notes that you can use really cheap grades of coal for the CTL process.
It seems to me like CTL puts a backstop on how high oil prices can remain in the long run, at least if coal production is not constrained. Of course in a world with a price on carbon emissions the CTL fuel is going to have to be a good bit cheaper than oil on a production-cost basis, since CTL involves about 3 times the amount of greenhouse gas emissions as conventional oil.
The MIT report on coal — my go-to reference for all things coal — estimates that liquid fuels can be produced using CTL for about $50 per barrel, and that you can add on carbon capture and storage relatively cheaply, raising the price to $55 per barrel [Appendix 3.F]. (NB: this assumes you build in CCS from the beginning and that you can clear the siting and technical hurdles involved in CCS.) That is a relatively low backstop. While I’m personally skeptical that the long-term price for oil will be quite that low, this does at least put in perspective current forecasts from the EIA or IEA that the long-term price of oil will be around $70-80 per barrel.
Posted by Daniel Hall on July 28, 2008
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.
Posted by Daniel Hall on July 17, 2008
Jeff Frankel argues that the Democrats are right to oppose off-shore drilling, but for the wrong reasons:
The Democrats have it precisely backwards. The problem with Republican proposals to re-open domestic oil drilling is not that we desperately need the oil right now, whereas new oil discoveries would not come on line for 5 to 10 years. Rather it is that we might truly desperately need the oil in 20 or 30 years, and so don’t want to use it up over the next decade. …
We don’t want to maximize current domestic production. Rather we want to leave the oil underground (or underwater) for decades, until we really need it, until we are so desperate that the economic benefits really do outweigh the costs.
This is the same dynamic that Rich mentioned a couple weeks ago: our decision to leave a bunch of our domestic oil in the ground looks like a pretty good investment decision now that oil is an order of magnitude more expensive than it was a decade ago.
But I am not convinced by Frankel’s argument that oil will march ever upward at astronomic rates and in 30 years we will be happy we left it in the ground. I can imagine states of the world where the price of oil is $20 in 30 years. (Perhaps a result of a battery-powered transportation fleet combined with electricity from renewables, nuclear, and CCS plants.) At the very least economic theory tells us that when both supply and demand are very inelastic that small changes in either can result in very, very large price changes. No one in 1980 thought oil could ever drop to $10 a barrel again. It did.
The dirty little secret of energy policy in the U.S. today is that opening up our domestic reservoirs would almost certainly pass any reasonable cost-benefit test.
The way to perform a cost-benefit calculation is not to assume that you know the future distributions of costs and benefits (as Frankel does). The cost and benefits we measure today are the best estimates we have. We should use them and have an honest debate about whether we want to drill domestically.
This doesn’t mean we shouldn’t try to give our best estimates of the distribution of future costs and benefits. Historically, our preference for environmental quality has risen over time. We should consider that the next generation may place an even greater value on a pristine ANWR or ocean shelf than we do. We should also try to think realistically about what oil prices are going to be.
But recall also that a couple weeks back I pointed readers to a research paper [ungated version here] that found that opening ANWR would lead to benefits of $1141 per person in the U.S., and this was at an oil price of around $53 per barrel. In other words, the environmental costs (or our willingness to pay to prevent environmental damages) would have to be more than $1000 per person if drilling in ANWR were going to fail a cost-benefit test. At current oil prices it seems inevitable that domestic drilling would pass.
This does not imply we should necessarily drill. There are many metrics besides dollar values for making decisions about our environmental management and energy policy. But I have yet to see anyone in this debate honestly state the facts about domestic drilling. The lie Republicans will tell you is that domestic drilling will lower oil prices. The lie Democrats will tell you is that because it won’t it’s not worth doing.
Posted by Daniel Hall on June 26, 2008
This paper provides model-based estimates of the value of oil in Alaska’s Arctic National Wildlife Refuge (ANWR). The best estimate of economically recoverable oil in the federal portion of ANWR is 7.06 billion barrels of oil, a quantity roughly equal to US consumption in 2005. The oil is worth $374 billion ($2005), but would cost $123 billion to extract and bring to market. The difference, $251 billion, would generate social benefits through industry rents of $90 billion as well as state and federal tax revenues of $37 billion and $124 billion, respectively. A contribution of the paper is the decomposition of the benefits between industry rents and tax revenue for a range of price and quantity scenarios. But drilling and development in ANWR would also bring about environmental costs. These costs would consist largely of lost nonuse values for the protected status of ANWR’s natural environment. Rather than estimate these costs and conduct a benefit–cost analysis, we calculate the costs that would generate a breakeven result. We find that the average breakeven willingness to accept compensation to allow drilling in ANWR ranges from $582 to $1782 per person, with a mean estimate of $1141.
And from the section of the paper on the benefits of drilling:
As stated previously, two benefits of drilling in ANWR that are often put forth are a decrease in the price of oil and reduced reliance on foreign imports. The numbers above suggest, however, that neither of these benefits is likely to be consequential. Domestic oil prices are determined in a world market and would be unaffected by the relatively small annual flows from ANWR. Moreover, the quantity of oil in ANWR, 7.06 BBO, is merely 0.55% of the proven reserves worldwide (EIA, 2006b). Analysts also recognize that even if ANWR’s supplies were large enough to affect world prices, the Organization of Petroleum Exporting Countries (OPEC) would countermand the increase in production and thereby negate any price effects (EIA, 2004; Gelb, 2005). It is also clear, with ANWR accounting for a maximum of 3.2% of domestic consumption in 2025, that something other than drilling in the Refuge will be necessary to substantially reduce our dependence on foreign oil.
The benefits that would be real and substantial are the economic rents and tax revenues that would arise from drilling in ANWR. From a social perspective—the one used in benefit–cost analysis—it is important to recognize that the oil is not worth the total revenue that it generates. There are opportunity costs associated with finding, developing, producing, and transporting the oil, along with the required rate of return on capital. The only portion of total revenue that would generate a benefit to society is the net return, which would consist of economic rent to the oil industry and state and federal tax revenues.
We extend the USGS model (Attanasi, 2005b) to estimate the economic rents and tax revenues that would arise from ANWR oil. The first step of deriving an estimate of total revenue is straightforward. For any given price, we multiply the price times the quantity of oil indicated by the long-run marginal cost curve in Fig. 1. Using our best-estimate scenario of $53 per barrel and 7.06 BBO, total revenue is $374.2 billion. Considering the 95% and 5% certainty scenarios, the estimate of total revenue ranges from $203.0 billion to $565.3 billion. Table 1 reports the estimates of total revenue for the full range of prices evaluated under the three different scenarios. [emphasis added]
Their alternative scenarios vary the amount of recoverable oil but not the price. They don’t consider prices above $59 per barrel. I’ll outsource the commentary to John Whitehead:
It is hard to imagine nonuse values over $1000 for ANWR (even if these are for households and not individuals). The nonuse values that I played around with 2 years ago are all less than $50.
Addendum: The values are for individuals age 18 or over.
Posted by Rich Sweeney on June 26, 2008
John McCain caught a lot of heat last week for proposing to open up offshore drilling. This is largely because he proposed doing so as a response to high gas prices. As people quickly pointed out, not only would it take 10 years before the first drop of oil came out of these offshore endeavors, but the entire operation would be so small relative to global production that it would have virtually no effect on the price of oil. In fact, as the WonkRoom noted, even McCain’s own advisers acknowledge that offshore drilling wouldn’t impact current prices. This prompted a predictably econo-idiotic restatement from the Maverick, where he tried to justify offshore drilling as impacting the psychological price of gas, not the actual price (maybe this is behavioral econ?).
However, talking to Daniel today about all of the the oil speculation nonsense today, we stumbled on a reasonable justification McCain could give to explain his offshore drilling flip flop: “I’m rich, Bitch!” As Wyatt Cenac brillantly explained on the Daily Show in response to Obama’s flip flop on accepting public financing, “we all say things we don’t mean just before we get rich….voters will forgive him once they take a ride in his brand new Hummer-copter.”
While, then as now, opening up off-shore drilling in the US won’t significantly reduce gas prices, what it will do is bring in a boatload of money to the US.* Back when oil was $20 a barrel, this revenue stream seemed far too small to sacrifice the serenity of of our oceans. But with analysts predicting $200 a barrel oil in the near future, it might be time for us to reconsider. When a democracy decides whether to conserve land or not, it values the costs and benefits of both options. I’m not saying we’re at a point now where we should drill, but it’s not entirely unreasonable to change one’s stance on an issue like this once the relative pros and cons have changed.
Which brings me to the point of this post. From a financial perspective, the decision to delay drilling in ANWR a decade ago is looking pretty prescient. Assuming that the resulting environmental damages and quantity of oil in the ground haven’t changed, it’d be much more beneficial to crack ANWR open now. As I see it, the public panic over recent run up in gas prices has less to do with the current level, and more to do with the fact that there’s no end in sight. If people believe that we won’t be able to wean ourselves off oil quick enough and that prices will continue to rise, then it should be somewhat comforting to know that if things really do get bad we can somewhat offset these negative effects by cashing in our untapped reserves. Otherwise, if people believe that the recent crunch is a brief abberation, that either oil prices will come down or we’ll simply learn to use a lot less of it, then it probably seems imprudent to permanently spoil the environment. Either way, a reasonable, informative public debate over the relative costs and benefits seems a lot more helpful than atemporal categorical rejections.
* In this example I’m assuming that the federal government would either auction off drilling sites, or extract royalties from companies who find oil offshore, and return a dividend of the proceeds to every American. In reality, most of the profits gained from offshore drilling would go to American oil companies. In the case of McCain’s plan, I think its pretty safe to assert that he’s thinking about placating Houston, not offsetting the increased transportation costs of American families.
Posted by Evan Herrnstadt on June 24, 2008
As I emerge from a long hiatus (Argentina and catching up with work upon my return), I’m going to ease back into blogging with a very brief econ 101 post. Hopefully my economic intuition and vernacular aren’t too rusty (feel free to tear into this post* — it’s the only way I’ll get back in stride). From the LA Times:
John McCain returned to Santa Barbara this week not to assert his opposition to offshore drilling — as he did when he ran for president in 2000 — but to make the calculated gamble that high gas prices have trumped voters’ desire to protect the environment…
We talk a lot about the environmental benefits of higher fuel prices as people change their lifestyles to reduce their consumption of fossil fuels. However, it’s easy to forget that in some locales, the opportunity cost equation for environmental protection can include increased oil supply. Essentially, conservation and fuel are an odd sort of complements. When the price of fuel goes up, the demand for environmental protection curve shifts inward. In the past, it seems that this cross-price interaction has been relatively inelastic, but this might be changing as we arrive at new reaches of the fossil fuel demand curve:
Los Angeles Times polls show that, in California, opposition to offshore drilling has not weakened even during past energy crises. But new national polls have shown that the country, burdened by exploding gas prices, supports drilling in sensitive areas.
Keep in mind that the impact on world oil prices from drilling in specific sensitive areas is likely to be small and somewhat temporally distant (see: ANWR), but this fact can easily be obscured by rhetoric and poor information. Luckily, politicians usually try to stay away from those kinds of things…
*I’m guessing Daniel and I might not be friends anymore by this afternoon.
Posted by Rich Sweeney on May 15, 2008
H/T to Thom for the first two links.
Posted by Daniel Hall on May 1, 2008
Yes, this McCain-Clinton idea to suspend the gas tax is stupid. I think the best quote I’ve seen so far comes from Len Burman via Greg Mankiw:
Yesterday I was on the NewsHour to talk about the gas tax holiday. I asked if there was another guest and the producer said, “We tried, but we couldn’t find anyone to argue the other side (that the gas tax holiday made sense).”
The more interesting part of the discussion is not the piling on — though certainly people should be pointing out how mind-bogglingly stupid this proposal is — but the discussion about tax incidence. Most commenters are arguing that producers will benefit more than consumers from the tax holiday, because summer oil supply is very tight. As Greg Mankiw describes it:
What you learn in Economics 101 is that if producers can’t produce much more, when you cut the tax on that good the tax is kept . . . by the suppliers and is not passed on to consumers.
Or here’s Paul Krugman:
Why doesn’t cutting the gas tax this summer make sense? It’s Econ 101 tax incidence theory: if the supply of a good is more or less unresponsive to the price, the price to consumers will always rise until the quantity demanded falls to match the quantity supplied. Cut taxes, and all that happens is that the pretax price rises by the same amount.
But Tim Haab is not so sure that supply is less responsive than demand. He nails the theoretical explanation. In fact, if you really want a great straightforward description of tax incidence, see this pair of posts he wrote just last month. Pay particular attention to the chart in the second post, which graphically depicts what he says here:
Only two cases are clear cut. If buyers are price insensitive and and sellers are price sensitive (top right panel), the buyer will bear the burden of the tax. If sellers are price insensitive and buyers are price sensitive (bottom left panel), sellers will bear the burden. In cases where both are sensitive or both insensitive, the results are unclear and depends on the relative sensitivities.
So when will supply of gas be perfectly inelastic? The most obvious answer to me would be when refineries are running at full capacity over the relevant range of prices. That is, regardless of the market price, refineries can’t keep up. Is that the case? The chart to the right gives U.S. refinery capacity and gasoline consumption in gallons per day from 2002-2007. On average, U.S. refineries produce at about 50% capacity. (emphasis added)
No. Just… no.
The problem is Tim compares refining capacity data to gasoline consumption. This is an apples-to-oranges comparison. Capacity is measured by the input — crude oil — and this is being compared to a specific output, gasoline. But refineries produce many things besides gasoline — jet fuel, home heating oil, etc. — and even if every U.S. refinery were optimized to make gasoline (which isn’t the case) there would still be losses from the refining process itself.
As it turns out the EIA* actually publishes weekly data on refinery capacity margins (or “percent operable utilization” as the EIA calls it). I downloaded the series to create the chart below. Note that with the exception of Katrina (September 2005) that refineries have run at 80-98% capacity over the last few years (most typically from 85-95%). Note that there is also a seasonal pattern: utilization usually declines in winter and peaks in summer. This would imply less elastic supply in summer. Note also, however, that refineries are entering this particularly summer with the lowest capacity utilization rates we seen in spring in awhile, around 85% instead of 90-95%.
What would I conclude from all this?
1. If you wanted to maximize the portion of this tax ‘refund’ that went to oil companies, you should make the gas tax holiday during summer, when supply is most inelastic.
2. Compared to previous years, producers would probably benefit less from the gas tax holiday this year, since capacity margins are down.
3. Despite the factual errors and the incorrect implication that summer gas supply is fairly elastic, Tim is probably right when he says, “maybe the tax holiday might have some effect on both consumers and producers.” Why is that? Remember, demand for gas is also very inelastic. In other words, which world are we in? I say the bottom right case in this chart.
This guy sums it up pretty well when he says,
the gains of the tax cut will be split evenly between producers and consumers… I’m not saying that the gas tax cut is a good idea. In fact, I think it’s horrible pandering that wont help anyone in the long-run.
*Public service announcement: when using energy data about the U.S. to back up any argument, please avail yourself of the EIA. If you can’t find what you need, look again. Still not sure? Check a third time. The EIA is amazing. Use it.