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Friday, March 25, 2005

Supply side or Demand side?

This is an interesting chart. In econometrics we talk about structural change in data, and this picture seems to have a structural break. Before December 2003, or so, the price of gasoline varied, mostly seasonally, around $1.50 to $1.60 per gallon. After December 2003, the price of gasoline marched steadily to a new plateau where prices now seem to vary around $1.90 per gallon.

It is possible that in the next couple of years the price of gasoline might steadily decline to return to the $1.50-$1.60 area, but I doubt that is going to occur. If this were 1988 or 1993 it might be possible, but the demand for oil in the 2000s is much greater than it was in the late 1980s, and it is not going decline, especially in Asia. Therefore, it is unlikely that gasoline prices here in the states are going to return to the good old days. In other words, there has been a structural change in the price of gasoline.

In a Heavy Lifting post from May of 2004, I argued that the days of $1.50 gasoline were gone for good. In that post I offered the following supply and demand side concerns:
Demand Side:

China is now the second largest daily consumer of crude (after the U.S.);

The vehicle miles driven in the U.S. continues to increase

Average miles-per-gallon of newer cars is lower than in previous decades (SUVs vs. mid-size sedans)

Supply side:

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;

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%;

Concerns about the steady flow of crude from the Middle East;

Increased costs of storing refined gasoline makes just-in-time production preferred

Doesn't seem like much has changed, except for the refinery explosion in Texas City this week. I agree that inflation adjusted gasoline prices are still fairly reasonable, and backstop technologies are likely to improve mpg in new cars. My point is that the jump in prices in December 2003 is fairly clear.

Another thought. September 2003 (or a little earlier) is when the dollar starts it's long slide against the Euro. Perhaps this has also had an influence on the transition from one price regime to the next. If the dollar has been permanently devalued against the rest of the world (something many economists would agree needed to happen), then the new price regime might well be stable.

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