High Gas Prices Hurt More NowPublished: June 30, 2004 in Knowledge@Emory
The average American consumes about 3 gallons of gas a day, compared to 1.4 gallons in other industrialized countries and .5 gallons for the world as a whole, according to the U.S. Energy Information Administration. Although the U.S. has cut back on its oil heating since the 1970s, it still relies on oil for 95% of its transportation needs, making the U.S. uniquely vulnerable among leading economies to jumps in oil prices.
Many businesses are hurt when the price of oil goes up, and not just such obvious candidates as the airlines. Convenience stores, for instance, suffer because more money spent at their pumps means less money for higher-margin goodies, according to reports of the National Association for Convenience Stores.
Business-to-business suppliers are hurt too. Richard Metters, a professor of decision-making and information analysis at Goizueta, says that in some respects many U.S. businesses are actually more reliant on oil than they were 10 or 20 years ago.
“It used to be that firms one or two decades ago would take the least–cost transportation method to get goods from one place to another. But with the prevalence of Just-in-Time systems, they don’t do that anymore,” he says.
While today’s Just-In-Time (JIT) delivery systems have saved retailers and manufacturers money by reducing their need to hold inventory, Metters notes that such systems have also decreased logisticians’ flexibility to shift between forms of transportation, since most JIT systems are designed around truck deliveries. Operations professionals sometimes joke that JIT really stands for Just in Trucks, he says. “They’re trapped in their JIT systems now,” observes Metters.
Not surprisingly, rising energy costs tend to be discouraging to Wall Street as well, says Jeff Busse , a Goizueta professor of finance. “It’s generally not a good time for the stock market. Everybody gets a little depressed, except for those producing oil,” he notes.
High energy can even be a contributing factor to interest rate hikes. “Generally, when prices go up, it makes people start worrying about inflation, then the Federal Reserve starts thinking about raising rates,” Busse says.
Why is the price high now? Professors say that some of the reason oil is now hovering around $40 a barrel may reflect concerns about war in the Middle East, and as such, the price could well decline in the next few months. “If some of these issues get resolved in the next couple of months or so, it seems like it could come down. Even if we should learn more and some of it’s bad, just knowing that can help things,” says T. Clifton Green, a professor of finance at Goizueta.
Green notes that it’s worth keeping in mind that commodity prices do have a tendency to be more volatile than supplies might actually warrant. “If you think about what happens to other types of commodities, orange juice and items like that, those prices also move around much more than the actual supplies do,” he says.
Estimates of how much war and terror concerns contribute to the current price vary. Widhyawan Prawiraatmadja, director of Facts Inc., a Honolulu energy analysis firm, estimates those fears probably add $2 to $4 to the current price of oil, which now hovers at around $40. He notes that Saudi Arabia’s recent pledges to increase its exports failed to make a dent in the price – indicating that market psychology rather than demand is driving prices these days.
The recent climb of gasoline prices has many consumers, investors, and business strategists worrying again. Although oil has still not reached its historic highs, when adjusted for inflation, it is now nearing some of the levels it hit in the 1970s. According to statistics from BP, in 1974, the price of a barrel of crude oil reached $42.40 in 2002 dollars – up from $13.70 in 1973 (again, priced in 2002 dollars). Through most of the 1970s, it hovered in what would now be the upper 30s. And then in 1980, it spiked to $78.19 in 2002 dollars.
Perhaps they are right to worry: In many ways, the country appears to be even more vulnerable to oil price shocks than it was in the 1970s, when oil prices last surged and helped keep the U.S. in difficult economic straits for much of the decade.
To begin with, the U.S. imports more oil than it did 25 years ago. Roughly 62% of oil needs are provided by overseas suppliers, compared to about 40% during the first oil shocks, according to statistics from the U.S. Energy Information Administration (EIA). Imports have grown from about 3 million barrels per day in the 1970s to over 8 million barrels per day, a number that outpaces the growth in population, which has grown from 205 million in 1970 to 280 million today. Proven domestic reserves are down 20% since 1990, and now stand at about 22.7 billion barrels.
The fact that oil is priced in dollars is also exacerbating the price swing, says Prawiraatmadja. The value of the dollar has declined by more than a third in the last two years, as compared to most leading currencies. As a result, Europe has experienced less of a price increase simply because the Euro is a stronger currency at the moment.
Another factor leading to higher gas prices – and explaining why gas prices have risen faster than oil prices over the past two years– has to do with the way gas is refined and distributed today.
One reason is that refineries don’t have much spare capacity to accommodate surges in demand. No new refineries have been built in the past 30 years, according to the EIA. Over 200 refineries have also closed since 1981, resulting in a net loss of capacity of approximately 4 million barrels a day. EIA analysts write that the refineries that closed tended to be small and unable to compete with larger, more efficient survivors. Some plants also required environmental improvements that owners chose not to invest in.
As a result, most refineries still operating are running at near capacity now, says Ujjayant Chakravorty, an Emory University professor of economics who specializes in energy issues. If anything goes wrong at a plant, spot shortages can arise very quickly.
To make matters worse, each refinery is configured to refine only certain grades of oil that originate in particular oil fields, explains Chakravorty. Some West Coast refineries, for example, are configured for Alaskan oil and can’t easily accept crude oil from other sources.
Beyond this industrial limitation, state and federal environmental regulations have inadvertently created even more regional market segmentation. To reduce air pollution, a number of states now require sale of their own special blends of gasoline, such as through a requirement to add ethanol to gas – a fact that makes sharing supplies between markets illegal. Some experts say it also discourages imports of refined fuels by European refineries, which used to sell their surpluses in the U.S. and often don’t want to make gasoline that can only be sold in a single market.
“If they don’t stop this proliferation of what we call fuel blends, or boutique fuels, you will actually have more and more types of fuel in circulation and the supply problems will be exacerbated,” Chakravorty warns.
The result: less oil from the Middle East, for instance, can’t just be made up by taking more oil from Venezuela. And more gas in New York can’t just be shipped south to alleviate a shortage in Atlanta. With less capacity and competition among refineries and more restrictions against movement of supplies between markets, the price of gas will continue to rise.
Beyond today’s short-term shortages, Chakravorty notes that there are longer-term reasons prices may stay high. For one thing, some of the biggest oil fields are in decline, not just because of declining reserves but because of a lack of investment needed to keep capacity up five or ten years down the line.
“For a country like Saudi Arabia, you can see that there’s a tension between long-run and short-run goals,” he says. In the long run, investing in the field might make the most sense, but in the short run, the government needs the money now. Many of these countries are actually running deficits, in spite of all their oil revenue. “These countries have become very, very dependent on oil revenue for all kinds of investment. Their economies are still oil-based, they haven’t diversified in any sense … and they have a huge population that is basically living off oil revenues,” he says.
Despite what the news may suggest, however, the world is not actually running out of oil any time soon, Chakravorty says – it’s just running out of cheap oil. “Say, for example, today crude oil goes up from $35 to $60 a barrel, then we’ll find a lot more oil in different parts of the world. There are hydrocarbons under the ocean that are available for exploitation, say at prices of $100 a barrel,” he says. “Scarcity is a question of `at what price?’”