Heavy Lifting - thoughts and web finds by an economist
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Tuesday, May 18, 2004

Baby watch continues...

Haven't had much time to post because of three pressing issues: a) impending birth; b) prepping a new course for the summer semester; c) working on a paper for presentation at the Western Economic Association in late June.

But, hopefully two of the three will be off the list in the next week and I can get back to posting in earnest.

However, I cannot let the current hot-air about gas prices go untouched.

Gas prices are continuing to increase, but this is not surprising. We need to understand that the days of $1.50 gasoline are probably never going to return. Why, it is as clear a case of supply and demand as we as economists could hope for.
Demand side:
  1. China is now the second largest daily consumer of crude (after the U.S.);
  2. The vehicle miles driven in the U.S. continues to increase
  3. Average miles-per-gallon of newer cars is lower than in previous decades (SUVs vs. mid-size sedans)

Supply side:
  1. Refinery capacity is 2/3 what it was in the early 1980s - it is impossible for the U.S. to refine more gasoline without expanding capacity;
  2. Reformulated gasoline and local regulations make it impossible for inventories to be shifted from areas of surplus to areas of shortage (or more specifically, areas of lower prices to areas of higher prices) and reduce fuel mileage by up to 10%;
  3. Concerns about the steady flow of crude from the Middle East;
  4. Increased costs of storing refined gasoline makes just-in-time production preferred

The reality is that while J.F.K. can lay back and suggest that the Bush administration is once again not doing right by the American people by not releasing 60 million barrels of crude from the Strategic Petroleum Reserve, there is nothing that can be reasonably done in the short to mid-term that will bring the price of gasoline down. The biggest bottleneck is not OPEC or even China, but the lack of refining capacity and the reformulation requirements. If the EPA had not made it impossible for the smaller refineries to operate (during the 1980s) we would likely not have seen such an increase in price.

The relationship between supply and demand is well known and inuitively obvious. A one time increase in supply by releasing the SPR would have no long term impact on price, unless it sent a signal to the oil futures market that the U.S. government will credibly become the oil supplier of last resort - which would be a disastrous policy to pursue (again, I claim that JFK should keep his mouth shut - his poll numbers improve when he doesn't introduce more bad ideas). To reduce price over the long-term, one or both of the following must happen: demand declines and/or supply increases. The former is unlikely in the short-run and the latter is unlikely in the long-run (given current NIMBY attitudes and enviro-alarmist propoganda).

It turns out that things are worse in other places.

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