Only in Orwell’s world is the answer ‘no.’
Only in Orwell’s world is the answer ‘no.’
G asoline prices are nothing if not visible, and that such prices are high and rising is unlikely to help the party holding the White House. Average U.S. gasoline prices have risen from about $2.87 per gallon a year ago to $4.31 (as of March 16), an increase of 50 percent. It is unsurprising, therefore, that the administration now has put forth several bogeymen as the sources of this pain at the pump. High gasoline prices represent “Putin’s price hike.” The oil companies are engaged in “price gouging” and “profiteering.” They are allowing thousands of approved leases on federal land to go unused. OPEC+ — 13 members of OPEC and ten other major producers — is producing too little.
We return to these claims below. But it is reasonable to observe first that presidents get more blame and more credit than they deserve in most contexts. It is important, then, to analyze the degree to which Biden administration policies can be held responsible for the recent increases in gasoline prices. What recent shifts in demand and supply conditions have driven the market?
Consider demand conditions first. World Bank data show that global real GDP declined about 3.3 percent from 2019 to 2020, largely as a result of the Covid pandemic. The OECD estimate for real global GDP growth is 3.8 percent for 2021 (fourth quarter over fourth quarter), with a projection of 3.9 percent for 2022.
For purposes of rough approximation, it is reasonable to assume that global primary energy consumption rises in proportion to real GDP growth, with such other important factors as weather conditions and economic shifts across sectors held constant. If global real GDP rises by around 8 percent for the two-year period between 2021 through 2022, then it is appropriate to make the rough assumption that there will be an increase of around 8 percent in global demand for primary energy, and for the gasoline market as well.
Such an increase in demand in combination with shifts in supply conditions might result in changes in market prices. Consider now the supply side of the U.S. gasoline market. Refinery throughput — the amount of crude oil and other feedstocks processed in U.S. refineries into such products as gasoline — was about 16 million barrels per day (mmbd) in the spring of 2019. That fell to about 14 mmbd a year later, and remained at about that level in the spring of 2021, rising to about 15.2 mmbd early this March.
This suggests that the increase in gasoline demand has taken place with substantial remaining excess capacity in U.S. refining — i.e., supply conditions are more or less “flat.” Accordingly, the strengthening of demand conditions is a dubious explanation for the sharp upward movement in gasoline prices over the last year. Even if we assume a moderate “tightening” effect on U.S. gasoline supply and refinery conditions, gasoline consumption would have had roughly to double to yield a price increase of 50 percent. Nothing even remotely close to that has happened.
The argument that rising crude-oil prices are driving gasoline prices is much less useful than commonly assumed, in that we still to need know why crude-oil prices are rising. Over the past year, the price of Brent crude oil has increased from $67.57 per barrel to $98.33, or 46 percent (as of March 16). The Energy Information Administration reports the following trends and projections for global crude-oil production and consumption in mmbd, for 2019–2022:
These data offer no obvious production–consumption-balance explanation for the recent sharp increase in crude-oil prices. It is far more useful instead to examine some economic basics of a resource that is “substitutable” over time: Crude oil can be produced and refined during the current time period or held back (in the ground or in inventories) to some future time period. Suppose that the market comes to believe that investment in exploration, development, transport, and processing of crude oil will become artificially constrained over time because of legislation or regulation either in place or reasonably foreseeable in the future. All things being equal, that will entail a reduction in future supplies and higher future prices.
What does that imply about current prices? Suppose that the market rate of interest relevant for evaluation of oil-industry investments (or for shareholders’ investment opportunities with dividend payouts) is, say, 5 percent. Revenues from the current sales of oil can be reinvested in a market portfolio with an expectation of a 5 percent rate of return.
Suppose also that the market expects crude-oil prices to rise over time at a rate greater than 5 percent because of the anticipated investment decline. Owners of crude-oil resources have a choice: They can produce the oil today, invest the revenues in some fashion (or pay dividends), and expect to earn 5 percent on a risk-adjusted basis. Or they can reduce production during the current time period, shifting it into a future time period, and expect in effect to earn more than 5 percent in the form of rising crude-oil prices. But that reduction in output today raises current prices, and the shift in production into the future reduces expected future prices, so that at any given moment the market equilibrium expected price path slopes upward at the market rate of interest.
Accordingly, an expectation that future investment will be constrained artificially has the effect of raising prices today. Why might the market expect such constraints on future investment? Look no further than the Biden administration’s policies for the answer. The “net-zero” crusade against fossil fuels is an obvious attempt to force a sharp decline in current and future production. There are the various decisions to constrain or disallow investments in pipelines and other such infrastructure, both by the administration directly and by such “independent” regulatory agencies as the Federal Energy Regulatory Commission. There are efforts to reduce the fossil industry’s access to capital, new fuel-economy rules based on a preposterous analytic framework, efforts to force a substitution of wind and solar electricity (which cannot work simply as a matter of electrical engineering) in place of conventional power generation, the newly tightened methane-emissions rule that will impose significant costs while providing a temperature reduction of five one-thousandths of one degree C, the de facto moratorium on lease sales on federal lands, and on and on.
And there is the newly emerging proposal for a “windfall profits” tax on crude oil. Like the crude-oil windfall-profits tax from the Carter era, this one has nothing to do with “profits.” It would instead be an excise tax on the difference between current prices and some historical average. Any such excise tax would reduce current output, obviously, but what has not been noticed widely is that any such tax reduces upside price potential for the fossil producers while doing nothing about downside price risks. In other words, it would shift the statistical distribution of expected prices to the left — that is, toward lower prices systematically — and thus would reduce the expected returns to investment in exploration and all the rest.
Global crude-oil output is approximately 100 mmbd; U.S. output has declined from about 12.3 mmbd in 2019 to 11.2 mmbd in 2021. It is hard to estimate potential U.S. production capacity, but a conservative assumption is 13.5 mmbd; and a second is that the market expects the net effect of Biden-administration policies to be a decline in long-run annual U.S. production from that to 8.5 mmbd, which was the approximate average annual U.S. production for 2010 through 2019. (Whether or not overseas output would increase as a response is highly speculative, in part because some of the same political pressures observed in the U.S. would exist elsewhere, at least in the West.)
Under reasonable assumptions about market conditions, the decline in long-run U.S. output — 5 mmbd, or 5 percent of global output — would result in a long-run global price increase of at least 25 percent. This market expectation would create the intertemporal shift discussed above, and thus an immediate price increase. The short-run price effect must be substantially greater than the long-run impact, in that the ability of the demand side of the market to adjust to rising prices grows with time. Accordingly, it should surprise no one that the immediate price effect that we have observed — 50 percent — is much larger.
The administration cannot blame the dollar-exchange rate for the surge in crude-oil prices, as the real-dollar index has increased by 6.6 percent since January 2021. More generally, the administration wants to pretend that none of this matters because the “clean-energy transition” will replace fossil fuels with alternative energy. That such alternatives cannot survive market competition without massive subsidies, guaranteed market shares, and other subventions is a reality that the administration is not eager to publicize. The alternative-energy nostrum is make-believe, as are the other administration excuses for the sharp increase in gasoline prices. They are the result of “Putin’s price hike,” a stance not consistent with the reality that gasoline prices have been rising since December 2020. The oil companies are engaged in “price gouging” and “profiteering,” an argument rather silly in that the international gasoline market is largely competitive; such purported profiteering in one market would induce an increase in gasoline exports to that market by exporters attempting to capture such high prices for themselves. Prices ought therefore to decline. Why has that downward price pressure not been observed?
Then there is the argument that oil producers are allowing “9,000” approved leases on federal land to go unused, a deeply disingenuous assertion. As noted by the Western Energy Alliance: Because there are 37,496 leases in effect, a 75 percent utilization rate would be “a historic high.” Many leases are mired in litigation by environmental groups politically aligned with the administration. Horizontal drilling means that individual leases are not usable without a complete geographic leasehold. The de facto leasing ban exacerbates this problem, and federal environmental reviews under the National Environmental Policy Act create years of delays.
So incoherent is the overall Biden policy on fossil fuels — increases in artificial constraints on domestic production and investment combined with exhortations that foreign producers increase their output, all in the context of a “climate crisis” for which there is no evidence — and so politically damaging are high gasoline prices, that we now find the administration reversing course and imploring domestic fossil producers to increase output.
The longer-term political implications of the administration’s incoherence, mendacity, and self-delusions are vastly worse. There is no easy route out of the corner into which the administration has painted itself; it must subject the citizenry to ever-greater dishonesty merely to get through an endless series of increasingly difficult news cycles. Accordingly, doubling down on perverse arguments will prove to be the path easiest to take, in particular given the administration’s obvious desperation not to alienate its supporters on the left. And so the administration inexorably will descend into Orwell’s world where war is peace, freedom is slavery, ignorance is strength. The Biden administration translation: Expensive energy is cheap, environmentally destructive energy is clean, and central planning will create utopia. That the American people are being subjected to such dishonesty is deeply perverse. But here we are.