Coyote Blog

The Thin Green Line passes on an editorial from today's SF Chronicle:

California should continue to lead the way in the fight against climate change by requiring cleaner-burning fuels in this state.

The state Air Resources Board is scheduled to vote today on whether to force refiners and distributors to reduce the "carbon intensity" of the transportation fuels they sell, starting in 2011. The so-called Low Carbon Fuel Standard represents a critical step toward this state's commitment to reduce overall emissions of heat-trapping gases by a third by 2020.
Passage of a California cleaner-fuels standard would intensify the pressure on Congress to make a national commitment to promote lower-carbon options to gasoline and diesel.

Holy moly, I never thought of this?  It's brilliant!  Let's just legislate that hydrocarbons should have less carbon!  And tell the refiners to figure it out.

In all seriousness, assuming this is not just insane (which may be a poor assumption in CA) I presume they have something in mind here.  Does anyone know what opportunity they see, because I sure don't.  Here is why I am confused:

Basically transportation fuels are made up various hydrocarbon chains.  The shortest is methane, CH4, then C2H6, then C3H8, etc.  As the chains get longer, the molecule gets heavier  (for example, CH4 is a gas at room temperatures; C3H8 is propane, which is a gas but a liquid under pressure in our BBQ tanks; C8H18 is octane and liquid at normal car operating temperatures.)

Motor fuel is a careful blend of many different molecules, and is actually frighteningly complex (the above just discusses straight chain forms, there are also rings and other shaped hydrocarbon molecules).  There are literally hundreds of specs it has to meet, and several present difficult tradeoffs that must be carefully balanced.  Trying to make one spec can easily put one out of another spec.  So this is an optimization equation with a lot of constraints.

All things being equal, decreasing the carbon intensity of fuel basically means making it lighter, with shorter molecules.  Why?  Well, look at the molecular equations.  Basically a straight chain hydrocarbon is C(x)H(2x+2).  Shorter molecules get a higher ratio of their BTU's from combustion of hydrogen vs. larger molecules get a higher ratio of their BTU's from carbon.

So, it is correct that burning propane in a car vs. currently formulated gasoline will be less carbon intensive, with only the teeny tiny problem that most cars today cannot burn propane.  Modern engines are carefully built to run most efficiently (valve design, cylinder pressure and size, air mixtures, fuel injection)  on a certain range of gasoline, and that range is moderately narrow.  And, besides the pure physics of engine design, lightening up motor fuels will create a variety of secondary problems -- for example, lighter fuels tend to have higher vapor pressures and volatility that can cause vapor lock in engines on warm days.  Another way to reduce carbon intensity is to go from ring molecules (e.g. benzine) to straight chains of the same size, but this creates other problems, for example in maintaining octane numbers.

And speaking of unintended consequences, my understanding is that environmentalists like diesel engines, because the best diesel technologies today are far more efficient than gasoline engines.  But diesel is a heavier, more "carbon intensive" fuel than gasoline.  So is the carbon dioxide emissions from a heavier fuel in an engine that is more efficient less or more than a typical gasoline engine?  Who knows, and the answer is probably "it depends" anyway.

Update: I think I have figured it out.  The California legislature is going to mandate changing the size of the 2p valance shell, allowing more hydrogen molecules per given carbon molecule.

Via Jim Kingsdale:

Since PHEV's [plugin hybrid electric vehicles] can have so much impact on both the energy investment outlook and national security, I follow with some interest the news about their likely availability.  Recently a picture is starting to emerge.  It is not positive for American car companies, of which G.M.'s Volt is the poster child.  This is not totally surprising given G.M.'s proven history of incompetence.

We know that the Volt's battery is so expensive that G.M. proposes to sell the car for $40,000 - a price that would eliminate most buyers.  And even with such a high price G.M. promises they would lose money on every vehicle.  So, as I've previously written, the Volt may well be more of a political strategy for G.M. than a likely transportation solution.   Now a new study by Carnegie Mellon University says the design of the Volt's propulsion system is inherently sub-optimal and uneconomical - "not cost effective in any scenario" in the words of the study.

The reason is quite obvious once you think about it.  G.M. designed the Volt battery to go 40 miles on a charge because, they "reasoned", some 90% of all drivers go no more than 40 miles in a day.  What Carnegie Mellon points out is that the average driver goes less than 20 miles in a day.  Therefore the Volt's battery is twice as large as necessary for some 50% of drivers .  Since battery weight and cost are the prime determinants of a PHEV's cost-effectiveness, the Volt battery is about twice as large as is economically practical for most drivers.

Here's how the report put it: "The Carnegie Mellon study, conducted by engineers from three different departments, constructed computer simulation models to determine the impact of additional batteries on fuel consumption and cost and greenhouse gas emissions over a range of charging frequencies.  It found that small-capacity plug-ins that get less than 20 miles per charge are more efficient than conventional hybrids. And it said that large capacity hybrids like the Volt that go 40 miles or further on a charge are never cost-effective, because the batteries cost and weigh too much.  A car with the Volt's range, according to the study, would also be extremely uneconomical traveling fewer miles as it hauls around battery capacity it doesn't need."

So much for the Volt.  Ciao - and lets hope the U.S. govt. is smart enough not to fall for the Volt's fools-gold as an excuse to keep G.M., a chronically mismanaged company, from enjoying the cleansing benefits of bankruptcy.  Among which benefits might be new management.

I'm thinking of the three major consumer purchases that are probably at the base of the hierarchy of needs:  Fuel, food, and shelter.  Its interesting how very different the media and public perception is of price changes in these areas.

The reaction to fuel price increases is easy to predict - they are always portrayed as bad.  Rising prices hurt everyone, producers are evil, and speculators who make bets on rising prices are even more evil.

The reaction to rising food prices is more mixed.  That's because we have come to the collective decision that producers of food are sympathetic figures whereas producers of oil are unsympathetic.  So media laments about rising food prices are often tempered by good news stories about rising farm profitability.

And then there is shelter.  For this category of consumer expenditure, everything is flipped on its head.  Rising prices are good, and falling prices are bad.  One might argue that housing is different, because consumers often take an equity position in shelter that they do not take in food or fuel.  But all this means is that home buyers are speculating on the price of shelter, going long on bets that prices will rise.  They could easily just rent, and pay for their shelter month-to-month like they pay for their food or fuel, but many consumers bet on rising rents and shelter prices by buying shelter futures (ie purchasing a home).  In a real sense, home buyers are all speculators (using margin accounts at that!), but this is one case where we encourage speculation, and even have tax subsidies for it.

If the reader finds this a funny way to think of home ownership, here is a thought experiment.  Let's say at the age of 30 I wanted to take an equity stake in my current and future fuel needs.  I take out a loan to buy enough Exxon stock such that the annual dividends will cover my fuel purchases for the year.  If fuel prices go up, the dividends likely go up as well, so I am sheltered from the vicissitudes of worrying about my monthly fuel bill, and all I have to do is pay off a regular and predictable mortgage on my Exxon stock.  In 30 years, when the note is paid off, likely I have a big capital gain in my Exxon stock, which I could cash in at retirement if I want to downsize to less driving and fuel use.  Or I can pass it on to my kids.

The only difference I can come up with, economically, between this example and how we do housing is that in my example, consumer capital is invested in productive enterprises rather than dead real estate.

Technocrats love to pick winners.  Leftish technocrats, in particular, love to believe that the complex operations of the entire economy choose technologies that are inferior to those the technocrat would have imposed on the economy had she been in charge.  But here is what happens when they try, in a cautionary tail that is particularly relevant given the number of specific technologies Barack Obama has said he would promote (e.g. a million plug-in hybrids by 2015) (via Tom Nelson)

The federal government has invested billions of dollars over the past 16 years, building a fleet of 112,000 alternative-fuel vehicles to serve as a model for a national movement away from fossil fuels.
But the costly effort to put more workers into vehicles powered by ethanol and other fuel alternatives has been fraught with problems, many of them caused by buying vehicles before fuel stations were in
place to support them, a Washington Post analysis of federal records shows.

"I call it the 'Field of Dreams' plan. If you buy them, they will come," said Wayne Corey, vehicle operations manager with the U.S. Postal Service. "It hasn't happened."

Under a mandate from Congress, federal agencies have gradually increased their fleets of alternative-fuel vehicles, a majority of them "flex-fuel," capable of running on either gasoline or ethanol-based E85 fuel. But many of the vehicles were sent to locations hundreds of miles from any alternative fueling sites, the analysis shows.

As a result, more than 92 percent of the fuel used in the government's alternative-fuel fleet continues to be standard gasoline. A 2005 law -- meant to align the vehicles with alternative-fuel stations -- now requires agencies to seek waivers when a vehicle is more than five miles or 15 minutes from an ethanol pump.

The latest generations of alternative vehicles have compounded the problem. Often, the vehicles come only with larger engines than the ones they replaced in the fleet. Consequently, the federal program --
known as EPAct -- has sometimes increased gasoline consumption and emission rates, the opposite of what was intended....

The Postal Service illustrates the problem. It estimates that its 37,000 newer alternative-fuel delivery vans, which can run on high-grade ethanol, consumed 1.5 million additional gallons of gasoline last fiscal year because of the larger engines.

The article does not even mention that E85 ethanol made mostly from corn does absolutely nothing to reduce total CO2 production (it just shifts it around, due to the amount of energy required to grow corn and convert it to ethanol) while raising food prices.

California did something like this years ago, putting the force of subsidies and state law behind zero-emission vehicles.  This wasted a lot of money on electric and hydrogen vehicles that were not yet technologically mature enough to prosper, while missing out on low (but now zero) emissions approaches that could have had much more impact because they were technologically ready (e.g. CNG for fleet vehicles).

Y'all know where I stand on the dangers of CO2.  But if we really have to do "something", then the only efficient way to do it is with a carbon tax.  But politicians hate this idea, because they don't want to be associated with a tax.  But the fact is, that every other action they are proposing is a tax of some sort too, but just hidden and likely less efficient.  There is no magic free lunch that Barack Obama and his folks can think of and impose, no matter how smart they are.  In fact, to some extent, smarts are a hindrance, because it tempts people into the hubris of thinking that they are smart enough to pick winners.

Postscript: If you are reading this and thinking "well, if I were in charge, I would not be that stupid and I could make it work" then you don't get it.  1)  No one can make it work, for the same reasons the Soviets could not plan their economy from the top -- its just too complex.  At best, policy-makers are choosing between a handful of alternatives to back.  In contrast, every individual has a slate of opportunities to reduce his/her CO2 production at the least cost, and when you add up all these individual portfolios, that means there are hundreds of millions of individual opportunities that must get prioritized.  That is what pricing signals do, but government bureaucrats cannot.  2) The morons and knaves ALWAYS take over.  Even if you are brilliant and well-motivated, your successor likely will not be. For years, folks have generally been comfortable with the outsized role of the Federal Reserve because they thought Greenspan  (and Volker before him) ran it brilliantly.  Well, there are arguments to be made about this, but even if we accept this judgment, what happens when the next guy is in charge and is not brilliant?

Postscript #2: If you want a specific example, let's take plug-in hybrids.  How can anyone be against these?  I personally like the concept of cars being driven by electric traction motors (I like the performance profile of them) and would love a good plug-in hybrid.  But what happens when we find out that many of these cars were bought in coal-burning areas where electricity is particularly cheap, and discover coal-fired electricity pollutes more than an internal combustion engine?  Or when we use a cap and trade system to cut back on coal fired plants, and find that the huge number of plug-in hybrids are exacerbating brown-outs and electricity shortages?  Or we find that the billions of dollars of capital diverted by the government to expanding plug-in hybrids could have easily yielded far more CO2 reduciton had it been applied in another area?  That is why a carbon tax is the only way to go (if we are going to do anything) because it allows individuals to make capital expenditure decisions to reduce CO2 based on their vastly higher knowlege of the opportunities and the pricing signal of the tax.

Kevin Drum is off his meds, and is generating a lot of good fodder for me today. I made a couple of small edits in the name of intellectual honesty:

The news keeps getting better and better. The House Democratic caucus just voted 137-122 to replace John Dingell (D"“General Motors) as chair of the Energy and Commerce Committee. The new chair will be Henry Waxman, who cares deeply about [0.01% changes in atmospheric composition] and will be a huge ally in the fight to get serious[ly high fuel and electricity prices] next year. This is change we can believe in.

I am willing to put my disagreement with a lot of the world on whether on not global warming is dangerous into the "reasonable people can disagree" category.  But it just strikes me as outright insanity to try to push forward and pretend that anything that makes a meaningful dent in CO2, and so which has to make a meaningful dent in fuel and electricity consumption, will require either massive shortages or much higher prices.  Even a third-way plan that says we will evade this trade-off with new technologies  (whatever the hell those are) faces the massive dead-weight-loss of having to obsolete perfectly good power generation or transportation infrastructure and replace it wholesale with trillions of dollars of new stuff.  If we found out tomorrow that exposed brick caused global warming, and all of our houses had to be knocked down and rebuilt, would anyone really think we were all richer for that?

The amazing thing to me is that the left has all gotten on the "this will be a net positive for the economy, 5 million jobs, blah blah" message.  This is nuts.  This is the broken windows fallacy on Barry Bonds' entire steroid inventory.  Folks often respond to me, "but we will gain because we will reduce the cost of global warming."  But reasonable, non-loony folks don't really honestly think we are incurring any costs right now from global warming.  There is an argument that they might exist 50 years from now and that they might be high enough to get started on now, but for the next 10 years or more, there is just cost, no benefit.

The technocratic compulsion is very seductive to a lot of people (including, I think, our President-elect).  I can't tell you how often I hear "if we just had one smart person to clean up the mess..."  But it never works.  Just think about this auto czar idea being trial-ballooned this week.  Even if you could find someone brilliant enough to perfectly discern and synthesize the diverse buying interests of a hundred million consumers, he can never have the right incentives sitting in that government job.  Pretty soon he has group A insisting that he needs to mandate more fuel economy and group B that he needs to protect union jobs and group C that he needs to save jobs in Michigan in preference to Ohio and group D advocating for Ohio over Michigan and... you get the point.  All rolled up with the incentive problem that if he actually solves the problem at hand, he will be out of a job, so you can bet the problem is never fully solved.

My wife read the Michael Lewis article and comes back to me and says "I can't imagine how you can read that and still oppose government intervention and increased regulation."  I said, "why?"  Sure, people screwed up and did stupid stuff, but no defender of capitalism promises that won't happen.  Besides, what regulation would you propose?  "I don't know, but someone smart should have been watching them."

And that is what the argument usually boils down to - someone smart should have been watching them.  But lots of smart people were watching all the time.  You can see one such person featured in Lewis's article.  Guys run all over Wall Street looking every day for some single digit basis point spread they can make money off of.  But untold wealth was just sitting there for someone who was willing to call bullshit on the whole CDO/CDS pyramid game.  These guys playing this game were searching for people to bet against them. 

And despite this, despite untold wealth as an incentive, and companies looking for folks to take the other side of their transactions, only a handful saw the opportunity.  Thousands of people steeped in the industry with near-perfect incentives to identify these issues ... did not.  What, then, were our hopes of having some incremental government bureaucrats do so?  Usually, after this kind of crisis, there are lines of pundits and writers ready to suggest, with perfect hindsight, new regulations to avert the prior crisis.  But, tellingly, I have heard very few suggestions. 

Back in the 1980's, everyone was freaked out about junk bond-financed hostile takeovers, greenmail, leveraged buyouts and the like.   Since, while this activity has not disappeared, the wackiest of this behavior has really died down.  Do you remember that act of Congress and subsequent regulation that really curtailed this behavior?  Yeah, neither do I.  The fact is that, if they are allowed -- and if they are not shielded by taxpayer-funded bailouts from the consequences of their actions -- individuals learn from their excesses.  Or they go bankrupt.

Don Boudreax shares this leftish view of the auto bailout from Pat Garofalo:

More importantly though - as Pelosi and Reid said - "federal aid should come with 'strong conditions,' such as requirements that car makers build more fuel-efficient vehicles." Bill Scher at OurFuture writes, "With the auto industry in dire straits, we taxpayers have maximum leverage to demand the cars necessary to help lower energy costs, cut carbon emissions and reduce our dependency on foreign oil."

So, uh, only when the government gets involved do consumers have any leverage with producers in terms of what products they produce?  Hello?  I'm sure Circuit City execs will be relieved to hear this.

In free markets, consumers have all the leverage in determining perhaps not what gets produced, but at least what gets sold in any marketplace.  Producers who are unable to match what they produce to what consumers buy eventually go bankrupt.  In fact, it is this process of consumers exercising their leverage with GM that Congress is attempting to interrupt with a bailout. Consumers are telling GM loud and clear that GM is not making the cars at the price points they want.  Unable to do so, GM will likely fail.  This failure will result either in 1) GM, under bankruptcy protection, shedding any number of constraints that are preventing it from making what the consumers want or 2) GM liquidating its production assets to other owner/management groups who can do a better job with them.

This quote is a great example of the technocratic bent many leading Democrats bring to economics.  What these guys are asking for is not leverage for consumers, but leverage for a few Democratic technocrats to makeover the auto industry the way they want it.  People like Nancy Pelosi who would never in a million years be given the keys to a manufacturing corporation by a sane ownership group can effectively grab that jobs via the leverage her seat in Congress gives her.

Postscript: Garofalo adds:

and if you think about the ripple effects, they are the backbone of our manufacturing economy." Indeed, according to estimates, one in 12 U.S. jobs is tied to car manufacturing, and a bailout of the industry could help boost the U.S.'s ailing manufacturing sector.

A couple of points.  First, a GM bankruptcy is hugely, enormously unlikely to mean the whole company is just shut down.  If you have flown in the last 10 years, unless you have favored only Southwest Airlines, you probably have traveled on a carrier in chapter 11.  That's what chapter 11 is - a breathing space while the company continues to operate but is able to restructure its liabilities.  Personally, I would love to see the company go chapter 7 and have a new wave of innovative people take over the assets and see what they could do with them.  But it is not going to happen.  GM may shed jobs over the next year, but they are going to do so anyway in the teeth of a recession, not because they went bankrupt.

Podesta must know that the issue in a bankruptcy will not be jobs, but labor contracts  (airlines have practically patented the chapter 11 vehicle for renegotiating union contracts).  Most GM manufacturing employees would probably keep their jobs through a bankruptcy, but they may well lose their contract that says they get paid $75.86 an hour with 34.5 days a year of paid leave.  Garofalo and Podesta are shilling for the union over wage bargaining, not jobs.

The other observation I want to make is to ask why the loss of these 250,000 jobs is going to be so much worse than the loss of 500,000 jobs over the last several years.

I know parts of Michigan suffered, but Podesta is claiming knock-on effects for the whole country.  So where were they?

The US Conference of Mayors has introduced a "study" extending on Obama's idea of millions of new green jobs:

A major shift to renewable energy and efficiency
is expected to produce 4.2 million new environmentally friendly "green"
jobs over the next three decades, according to a study commissioned by
the nation's mayors.

The study to be released Thursday by the U.S. Conference of Mayors,
says that about 750,000 people work today in what can be considered
green jobs from scientists and engineers researching alternative fuels
to makers of wind turbines and more energy-efficient products.

But that's less than one half of 1 percent of total employment. By
2038, another 4.2 million green jobs are expected to be added,
accounting for 10 percent of new job growth over the next 30 years,
according to the report by Global Insight, Inc.

Well, lets leave aside the measurement issue of making forecasts and establishing targets for metrics like "green jobs" that can be defined however the hell someone wants.  For example, if they really were to define "green jobs" as they say above "makers of ... more energy-efficient products," then nearly everyone in industrial America already has a green job.  Every car made today is more fuel-efficient than the equivalent car made 20 years ago, every motor more efficient, every machine more productive.

But lets discuss that word "incremental."  Politicians NEVER, EVER cite job growth projections that are truly incremental.  For example, tariff program X might be billed as saving 100 jobs in the steel industry, but what about the jobs lost in the steel-consuming industries due to higher costs?  The same is most certainly true in this whole "green jobs" fiasco.  It is the perfect political promise - impossible to define, impossible to measure, and therefore impossible to establish any accountability.  Everyone who makes the promise knows in his/her heart the jobs are not truly incremental, while everyone who hears the promise wants to believe they are incremental.  Politics thrives on this type of asymmetry.

I looked before at the impossibility of these numbers being incremental, but here is a second bite of the apple.  The article says specifically:

The report, being presented at a mayor's conference in Miami, predicts
the biggest job gain will be from the increased use of alternative
transportation fuels, with 1.5 million additional jobs, followed by the
renewable power generating sector with 1.2 million new jobs.

Let's take the second number first.  Here are the current US employment numbers for the US power generation field:

Construction of power generation facilities:	137,000
Power generation and supply:	399,000
Production of power gen. equipment	105,000

That yields a total of 641,000.  So is it really reasonable to think that these green plans will triple power generation employment?  If so, then I hate to see what my electricity bill is going to look like.

The fuel sector is similar.  There are about 338,000 people employed in petroleum extraction, refining, transportation and wholesale -- a number that includes many people related to other oil products that are not fuels.  Add in about 100,000 for industry supplies and you get perhaps 450,000 jobs current tied to fuel production plus 840,000 jobs in fuel retailing (ie gas stations).  How are we going to add 1.5 million net new jobs to a fuel production sector with 450,000** currently?  And if we do, what is going to happen to prices and taxes?  And if the investments push us away from liquid fuels to electricity, don't we have to count as a loss 840,000 retail sector jobs selling a product no longer needed?

** Your reaction may be that these job numbers look low.  They are all from the BLS here.  Here is a quick way to convince yourself there really are not that many people working in the US oil and gas industry:  Despite years of mismanagement and government subsidies, politicians continue to fawn over auto companies.  Despite years of excellence at what they do, politicians demonize oil companies.  The reason has nothing to do with their relative performance, ethics, importance to the country, greed, etc.  The difference is that the auto companies and their suppliers employ millions of voters.  Oil companies employ but a few.

This is such ridiculous garbage as to be unbelieveable, but every paper in the country will print this credulously.  Because if journalists were good with numbers, they wouldn't be journalists, they'd be doing something that pays better.

As I have pointed out any number of times, when supplies of something are short, you can allocate them either by price or by rationing.  Robert Rapier, via Michael Giberson made the point that combining shortages with tough state price-gouging laws inevitably led to rationing and long lines:

Someone asked during a panel discussion at ASPO whether we were going
to have rationing by price. I answered that we are having that now. But
prices aren't going up nearly as much as you would expect during these
sorts of severe shortages. Why? I think it's a fear that dealers have
of being prosecuted for gouging. So, they keep prices where they are,
and they simply run out of fuel when the deliveries don't arrive on
time. If they were allowed to raise prices sharply, people would cut
back on their driving and supplies would be stretched further.

Neal Boortz made the same point yesterday, as the gas shortages in the southeast dragged out (unsurprisingly) for a second week:

nearly 200 gas stations in Atlanta are being investigated for price gouging.  Don't investigate them!  Reward them!  Price gouging is exactly what we need!  It should be encouraged, not investigated....

The real problem now is panic buying.  People will run their tanks
down by about one-third and then rush off to a gas station.  Lines of
cars are following gas tanker trucks around Atlanta. The supplies are
coming back up, but as long as people insist on keeping every car they
own filled to the top and then filling a few gas cans to boot, we're
going to have these outages and these absurd lines. 

So, how do you stop the panic buying?  Easy.  You let the market do
what the market does best, control demand and supply through the price
structure.  The demand for gas outstrips the supply right now, so allow
gas stations respond by raising the price of gas .. raise it as much as
they want.  I'm serious here so stop your screaming.  The governor
should hold a press conference and announce that effective immediately
there is no limit on what gas stations can charge for gas.  I heard
that there was some gas station in the suburbs charging $8.00 a
gallon.  Great!  That's what they all should be doing.  Right now the
price of gasoline in Atlanta is artificially low and being held down by
government.  That's exacerbating the problem, not helping it.  Demand
is not being squelched by price. 

As the prices rise, the point will be reached where people will say
"I'm fed up with this.  I'll ride with a friend, take the bus or just
sit home before I'll pay this for a gallon of gas."  Once the price of
a gallon starts to evoke that kind of reaction, we're on our way to
solving the problem.  When gas costs, say, $8.00 people aren't going to
fill their tanks.  They also aren't going to rush home to get their
second car and make sure it is filled up either ... and you can forget
them filling those portable gas cans they have in the trunk.  Some
people will only be able to afford maybe five gallons!  Fine!  That
leaves gas in the tanks for other motorists.  Bottom line here is that
people aren't going to rush out to fill up their half-empty tanks with
$8.00 gas.

Here is something else to think of about lines and shortages.  What is the marginal value of your time?  I think most people underestimate this in their day to day transactions.  Some will say it is whatever they make an hour at work, and that is OK, but I will bet you that is low for most folks.  Most folks would not choose to work one more hour a week for their average hourly rate.  Start eating into my free time and family time, and my cost goes up.  That's why overtime rates are higher.   

So let's say an individual values his/her time at the margin for $25.  This means that an hour spent waiting in line or driving around town searching to fill up with 10 gallons raises the cost by $2.50 a gallon.  And this does not include the fuel or other wear on the car used in the search.  Or the cost of that sales meeting you missed because you did not have the gas to get there.  So an anti-gouging law that keeps prices temporarily down by a $1 or so a gallon may actually cost people much more from the shortages it creates.   

Several people I know have argued with my "do nothing" approach to the current mortgage and liquidity mess.  Their argument is that the current crisis has frozen the short term money market, with banks refusing to lend to each other, and only doing so via central banks.  The problem, they claim, is that this could lead to an extended drying up of business to business credit.  For example, two people both used the fuel retailing example, arguing that inventory purchases are made on credit, and paid off as the inventory is sold.  The logic, I assume, is that businesses have all reduced their working capital, and so a drying up of short term business credit will cause the economy to lock up, with producers and retailers unable to buy components and inventory.  One such argument here.

I guess the questions are 1) for how long and 2) how best to fix it.  To the first question, this is by no means the first time in my lifetime that short-term credit has dried up.  Liquidity eventually returns, mainly because lenders need to lend as much as borrowers need to borrow.  As to the second question, central banks are currently handling this by increasing the amount of money they will lend short term.  Rather than lend to each other directly, bank A deposits with the Fed and then the Fed lends to bank B.  The cycle ends NOT when every bank is healthy but when banks and other institutions are confident they know which banks are healthy.  All the bailout is doing is delaying this reckoning.  I don't think it matters that banks and certain financial institutions survive, I think it matters that the ones who are not going to survive are identified quickly so the rest can start lending again to each other.

Given these concerns, I reiterate my position that if the government is going to inject liquidity and create new financial asset insurance programs, it makes more sense to me to do it at the point of concern, i.e. in the credit market to main street businesses, rather than dumping the money into the toxic sludge of credit default swaps. 

I was just volume-gouged on gasoline today in Atlanta.  I was returning my rent car, and needed to fill the tank.   Stations here seem to fear a hurricane-related gas shortage, to the first station would only sell me 10 gallons maximum.  The second claimed to be out of gas.  At the third I was able to fill my tank the rest of the way.  These stations gouged me on volume, simply because they didn't have the simple courtesy to re-price their product upwards in a shortage in order to ensure continued availability of supply.

By the way, memo to news guys -- telling everyone to run out and fill their tanks RIGHT NOW in order to avoid a possible gasoline shortage will only precipitate said shortage.  If everyone fills his or her tank at the same time, this shifts inventory from large regional reservoirs to individual reservoirs (e.g. gas tanks), the most inefficient of inventory storage models.  Having every car's gas tank go nearly instantaneously from 5/8 full to full requires something like 600 million gallons of draw down from retail and wholesale inventory to car fuel tanks.  The system cannot survive that in 24 hours, and the hypothesized shortage becomes a reality.

Postscript:  By the way, the question of whether to run out and fill your tank tonight is a classic prisnoners dilemma game.  We are all better off if no one does it, but each invidividual probably maximizes his or her well-being by deciding to fill up, so everyone does it.

If the world's citizens will not freely lend the Big Three automakers money of their own free will, then Congress is considering using force to make it happen.

Auto industry allies hope to secure
up to $50 billion in federal t loans this month to modernize plants and
help struggling car makers build more fuel-efficient vehicles.

Congress returns this coming week from its summer break, and the
auto industry plans an aggressive lobbying campaign for the
low-interest loans.

I wrote earlier on why we should not be afraid to let GM fail.  Paul Ingrassia makes this point:

Any
low-interest loans to develop fuel-efficient cars should be made
available to all car companies, not just the Detroit Three. The law
passed by Congress last year is framed to make this highly unlikely.
But if developing fuel-efficient and alternative-energy cars is deemed
worthy of taxpayer subsidies for public-policy purposes, it's just
common sense not to put all our eggs in Detroit's basket.

I would have gone further and said that US automakers are perhaps the last one's one would entrust with limited capital resources to develop such a new technology.  What would have happened to the PC revolution had the government circa 1975 limited all the available investment capital for new computing technologies to IBM, DEC, Honeywell, etc.

No, the news itself is good news, not bad:

This week, the Republican Party in its national platform called for an end to ethanol mandates in just the latest shot at a fuel alternative that, in some circles, has grown more target than treasure.

This was the part that was depressing:

High ranking politicians, including presidential candidate John McCain,
have publicly opposed ethanol subsidies before, but the platform
approved during the Republican convention in St. Paul, a corn-belt
capital, marks the first time a major U.S. party has taken an official stance against publicly funded ethanol incentives.

Talk about the emperor's new clothes.  If only we could get the first step on the campaign trail out of Iowa.

If you have watched the Olympics at all, you have likely seen the Obama commercial promising:

"The hands that install roofs can also install solar panels. The hands
that build today's cars can also build the next generation of
fuel-efficient vehicles. Barack Obama [will] ... create 5 million jobs developing homegrown energy technologies."

A few reactions:

• Private individuals, not politicians, create jobs
• Job promises like this are never incremental, nor can they be.  If the hands that build current SUV's can build electric cars instead, then we haven't added any new hands, we've just changed what they are working on.
• It strikes me that this is the broken windows fallacy writ large.  In effect, Obama promises to make much of our perfectly-serviceable transportation and electrical generation installed base obsolete, requiring an enormous effort to replace it.  But the resources to fund this huge new investment have to come from somewhere.  Industries that flourish and grow under this government enforced shift in capital will be offset by those that are starved.  Every other part of the economy will slow due either to higher taxes or higher prices (or both) that subsidize this effort.  But since it is harder to find and count the latter than the former, it makes for a good, un-auditable political pledge
• I'll bet that 5 million number focus groups really well, but does it make any sense at all?  Here are some current employment numbers for the US as of January, 2008:

OK, so the total employment of all these industries that might be related to an alternate energy effort is about 2.28 million.  So, to add 5 million incremental jobs would require tripling the size of the utility industry, tripling the size of the utility construction and equipment industry, tripling the size of the auto industry, tripling the size of the aircraft industry, and tripling the size of the shipbuilding industry.  And even then we would be a bit short of Obama's number.

I generally have a bet I make for new light (and heavy) commuter rail systems.  I bet that for the amount the system cost to build, every single daily rider could have instead been given a Prius to drive for the same money; and, with the operating losses and/or subsidy the system requires each year, every one of those Prius drivers could be given enough gas to make their daily commute.  And still have money left over.  I have tested this bet for the systems in Los Angeles and Albuquerque.

Well, it turns out I left something out.  Many people are interested in commuter rail because it is perceived to be greener, which nowadays generally means narrowly that it uses less energy and thus produces less CO2.  But in fact, it may not.  Blogger John Moore sent me a link to this article by Brad Templeton analyzing energy usage in various transportation modes.  While a full train can be fairly efficient (just as a full SUV could be if 7 passengers were in it), cars and trains and busses are seldom full.  When you look at their average load factors, trains are seldom better than cars:

In fact, a car at its average load factor (1.57 pax) has about the same energy use as busses or light rail per passenger mile.  The analysis is difficult to do well, but even with errors, its clear that rail projects do not dominate over car travel in terms of energy use  (One must be careful to differentiate rail project construction decisions from individual choice of mode decisions -- an individual at the margin shifting from car to train saves a lot of energy;  a city choosing to invest in a large new rail system to entice drivers off the road does not).

In fact, relevent to my bet, Mr. Templeton says this:

My first conclusion is that we would get more efficient by pushing
small, fuel efficient vehicles instead of pushing transit, and at
a lower cost.

He explains his results, which are counter-intuitive to many

A full bus or trainload of people is more efficient than private cars,
sometimes quite a bit more so.   But transit systems never consist
of nothing but full vehicles.   They run most of their day with light
loads.  The above calculations came from figures citing the
average city bus holding 9 passengers, and the average train (light
or heavy) holds 22.   If that seems low, remember that every packed
train at rush hour tends to mean a near empty train returning down
the track.

Transit vehicles also tend to stop and start a lot, which eats
a lot of energy, even with regenerative braking.   And most
transit vehicles are just plain heavy, and not very aerodynamic.
Indeed, you'll see tables in the DoE reports that show that over the past 30 years,
private cars have gotten 30% more efficient, while buses have
gotten 60% less efficient and trains about 25% worse.   The
market and government regulations have driven efforts to make cars
more efficient, while transit vehicles have actually worsened.

In order to get people to ride transit, you must offer frequent
service, all day long.  They want to know they have the freedom to leave at
different times.  But that means emptier vehicles outside of
rush hour.   You've all seen those huge empty vehicles go by, you just
haven't thought of how anti-green they were.    It would be better
if off-hours transit was done by much smaller vehicles, but that
implies too much capital cost -- no transit agency will buy enough
equipment for peak times and then buy a second set of equipment for
light demand periods.

A lot of his data can be checked at the US Department of Energy data book here.  In particular, you can see the key numbers in table 2.12.  After perusing this data for a bit, I had a few other reactions:

• Commercial air travel gets a bad rap.  On a passenger mile basis, it is really not worse than driving and only about 20% worse than Amtrack  (and probably the same as Amtrak or better if you leave out the Northeast Corridor). (table 2.14)
• Busses have really gotten way more inefficient over the years, at the same time cars have become substantially more efficient.  While the government criticizes its citizens for not practicing enough energy conservation, in fact its citizens have been buying more and more fuel efficient vehicles while the government has been buying less efficient vehicles.  (table 2.13)
• While passenger cars have increased substantially in efficiency, over the road trucks have seen no progress, and have actually gotten less efficient over the last 10 years (table 2-18)

Make sure to read the whole article.  I think the author is pretty fair at achnowleging where the uncertainties are in the analysis.  He also has comparisons of mass transit energy numbers between cities.  A few individual cities seem to beat even the most efficient cars -- most, including places like New York, do not.

Postscript:  I don't think numbers for New York include taxis.  If they did, New York would likely look terrible.  From an energy standpoint, taxis are a horrible transportation option, perhaps the worst possible.  It would be interesting to know how many New Yorkers who look down on SUV's routinely get around town using taxis.

US Airways has chosen to try to cover rising fuel prices by unbundling their ticket price and charging for services that were here-to-fore free, or built into the base ticket price.  They now charge $15 for the first piece of checked baggage ($25 for the second), and charge for most in-cabin services, including for soft drinks.

I'm not going to argue with them about this.  Airline pricing is a wickedly complex topic, and folks who know more than I do think this is the best way to get incremental revenue.  Really, these charges don't affect me (I almost never check bags, except when on vacation with my family).  In fact, as I write this, it strikes me that the baggage charge is really a price hike mostly on non-business travelers, which is interesting as it bucks the trend of having increasing price spreads over the years between business/last-minute and tourist pricing.

Anyway, the net effect has been to absolutely jam the security screening station this morning.  Every passenger seems to be carrying every bag he or she can on board to avoid the $15 charge.  What a mess.  I can't wait to see what the boarding process is going to be like.  Glad I don't have any bags today.

By the way, a few weeks ago I shipped a 60 pound trunk to my kids' camp for about $16 via UPS.  If these airline bag charges stick, it might be time for UPS to start soliciting the send-your-luggage-ahead business in earnest.  Next time we go skiing or some such place, I am going to seriously consider sending a couple of duffle bags ahead by UPS.

Update: The luggage bins were completely full before the fourth group out of six were called.  There was a fairly long line down the jetway of people gate-checking their bags.  Apparently, the airline is not set up to charge the $15 when they gate-check the bags, so everyone is hauling all of their bags to the gate and either bringing them on the plane or checking them at the gate for free.

A few weeks ago, Kevin Drum had a post on shale oil development, quoting from a speech by Congressman Ken Salazar.  It is hard to really excerpt the piece well, but my take on their argument against shale oil leasing is:

• Shale oil technology is unproven
• The government is leasing the shale oil rights too cheap
• There is already plenty of shale oil land for development, so new leases won't increase development
• This is just being done by the Bush Administration to enrich the oil companies
• The administration is rushing so fast that Congress has not had the chance to put a regulatory regime in place

In many ways, the arguments are surprisingly similar to those against new offshore and Alaskan oil leasing.  Through it all, there is this sort of cognitive dissonance where half the arguments are that the oil won't be developed, and the other half seem to be based on an assumption that a lot of oil will be developed.  For example, how can the leases be "a fire sale" if shale oil technology is unproven and development is not likely to occur?  I would say that if these assumptions were true, then any money the government gets for a worthless lease is found money. 

Similarly, how are oil companies going to enrich themselves by paying for leases if the technology is not going to work and no development is going to occur?  This same bizarre argument became Nancy Pelosi's talking point on offshore oil leasing, by saying that oil companies were somehow already cheating us by not drilling in leases they already have.  Only the most twisted of logic could somehow come to the conclusion that oil companies were enriching themselves by paying for leases were they found no developable oil.

From the standpoint of Democratic Party goals, there is absolutely nothing bad that happens if the government leases land for oil shale or oil drilling and oil companies are unable to develop these leases  (there is some small danger of royalty loss if leases are not developed when they could be economically, but most private royalty agreements are written with sunset periods giving the lease-holder a fixed amount of time to develop the lease or lose it -- I don't know how the government does it).  The net result of "no drilling" or "oil shale technology turns out not to work" is that the government gets money for nothing. 

Here is the problem that smart Democrats like Drum face, and the reason behind this confusing logic:  They have adopted environmental goals, particularly the drastic reduction of CO2 in relatively short time frames, that they KNOW, like they know the sun rises in the east, will require fuel and energy prices substantially higher than they are today.  They know these goals require substantially increased pain and lifestyle dislocation from consumers who are already fed up with fuel-cost-related pain.  This is not because the Democrats are necessarily cruel, but because they are making the [faulty] assumption that the pain and dislocation some day from CO2-driven global warming outweighs the pain from higher priced, scarcer energy.

So, knowing that their policy goal is to have less oil at higher prices, and knowing that the average consumer would castrate them for espousing such a goal, smart Democrats like Drum find themselves twisted into pretzels when they oppose oil development.  They end up opposing oil development projects because in their hearts they want less oil around at higher prices, but (at least until their guy gets elected in November) they justify it with this bizarre logic that they oppose the plan because it would not get us oil fast enough.  The same folks who have criticized capitalism for years for being too short-term focused are now opposing plans that don't have a payoff for a decade or so.

At the end of the day, most Democrats do not want more oil developed, and they know that much higher prices will be necessary to meet their climate goals.  It sure would be refreshing to hear someone just say this. As I wrote at Climate Skeptic, the honest Democrat would say:

Yeah, I know that $4 gas is painful.  But do you know what?  Gas
prices are going to have to go a LOT higher for us to achieve the CO2
abatement targets I am proposing, so suck it up.  Just to give you a
sense of scale, the Europeans pay nearly twice as much as we do for
gas, and even at those levels, they are orders of magnitude short of
the CO2 abatement I have committed us to achieve.  Since late 2006, gas
prices in this country have doubled, and demand has fallen by perhaps
5%.  That will probably improve over time as people buy new cars and
change behaviors, but it may well require gasoline prices north of $20
a gallon before we meet the CO2 goal I have adopted.  So get ready.

Postscript:  By the way, oil companies have been trying to develop shale oil since the 1970s.  Their plans went on hold for several decades, with sustained lower oil prices, but the call by the industry to the government for a clarified regulatory regime has been there for thirty years.  The brief allusion in Salazar's speech to water availability is a valid one.  I saw some studies at Exxon 20+ years ago for their Labarge development that saw water availability as the #1 issue in making shale oil work.

PPS:  I mention above that the pain of fuel prices not only hits the wallet, but hits in term of painful lifestyle changes.  One of the things the media crows about as "good news" is the switch to mass transit from driving by a number of people due to higher oil prices.  This is kind of funny, since I would venture to guess that about zero of those people who actually switched and gave up their car for the bus consider it good news from their own personal life-perspective.  Further, most of the reduction in driving has been the elimination of trips altogether, and not via a switch to mass transit.  Yes, transit trips are up, but on a small base.  95%+ of reduced driving trips are just an elimination of the trip.  Which is another form of lifestyle pain, as presumably there was some good reason to make the trip before.

Update: Updated on Canadian Oil Sands production here.  Funny quote:

Fourth, and potentially most important, the U.S. "green" lobby is
pushing legislation that could limit purchases of oil sands products by
U.S. government agencies based on its GHG footprint.  It would be well
beyond stupid for Congress to prohibit our buying oil from Canada while
we increase buying it from countries that threaten our security.  But
just because something is stupid certainly does not mean Congress may
not do it.

Y'all may have already seen these -- being on vacation, I am a little late to the table on both.  The first is a report on the Missouri state ethanol mandate:

A report from a Missouri-based research organization
debunks the claim that Missourians are saving money through a state law
requiring that retail gasoline contain a minimum of 10% ethanol. The
report is in reaction to an assertion by the Missouri Corn
Merchandising Association (MCMA), alleging that Missourians will save
more than US$ 285 million through the E-10 mandate in 2008, and nearly
US$ 2 billion over the following decade.

The MCMA arrived at these numbers by taking the price
difference between pure-grade gasoline and E-10 blended fuel, and
multiplying it by Missouri's projected annual consumption.

However, the report by the Show Me Institute reveals two fundamental flaws with this calculation. One
is that it fails to take into account the fact that E-10 blended fuel
is cheaper because ethanol producers receive tax credits and other
subsidies.

"Government officials cannot simply take tax dollars from
the public, give those tax dollars to ethanol blenders, and then have
ethanol supporters tell the public that ethanol is saving them money
with cheaper fuel as though the subsidy never existed," write the
report's authors, Justin P. Hauke and David Stokes.

The MCMA also does not take into account that E-10
blended fuel is about 2.5% less efficient than pure-grade gasoline,
meaning that Missourians will be filling their tanks more often.

When both of these factors are taken into account, the ethanol blending mandates are shown to be costing Missourians about US$ 118 million per year.

The second is a World Bank report on the effect of ethanol mandates on food prices:

Biofuels have forced global food prices up by 75% - far
more than previously estimated - according to a confidential World Bank
report obtained by the Guardian.

The damning unpublished assessment is based on the most
detailed analysis of the crisis so far, carried out by an
internationally-respected economist at global financial body.

The figure emphatically contradicts the US government's
claims that plant-derived fuels contribute less than 3% to food-price
rises. It will add to pressure on governments in Washington and across
Europe, which have turned to plant-derived fuels to reduce emissions of
greenhouse gases and reduce their dependence on imported oil.

Senior development sources believe the report, completed in
April, has not been published to avoid embarrassing President George
Bush.

"It would put the World Bank in a political hot-spot with the White House," said one yesterday....

[The report] argues that production of biofuels has
distorted food markets in three main ways. First, it has diverted grain
away from food for fuel, with over a third of US corn now used to
produce ethanol and about half of vegetable oils in the EU going
towards the production of biodiesel. Second, farmers have been
encouraged to set land aside for biofuel production. Third, it has
sparked financial speculation in grains, driving prices up higher.

Other reviews of the food crisis looked at it over a much
longer period, or have not linked these three factors, and so arrived
at smaller estimates of the impact from biofuels. But the report
author, Don Mitchell, is a senior economist at the Bank and has done a
detailed, month-by-month analysis of the surge in food prices, which
allows much closer examination of the link between biofuels and food
supply.

The report points out biofuels derived from sugarcane, which Brazil specializes in, have not had such a dramatic impact.

All this stuff was known long before Congress voted for the most recent ethanol mandates.  Why is it that the media, who cheerled such mandates for years, is able to apply any institutional skepticism only after the mandates have become law?  Are we going to have to actually pass some awful version of carbon trading before anyone will consider its inherent problems?

Holman Jenkins argues that despite the fact that GM's all-electric car the Volt will likely lose money on every sale, GM knows exactly what it is doing with this program.  The main customer, apparently, is not the end consumer, but the government.  GM is betting that an Obama, beholden in his new presidency to unions and environmentalists, will be open to a massive government subsidy of the US auto industry.  The Volt program may be part of a plan to buff up GM's attractiveness at the government trough:

GM executives are not nuts. They justify the costs and
risks of the Volt as a way of changing GM's image in the minds of
consumers and politicians. To commit a pun, the Volt is GM's vehicle
for making a bailout of GM politically acceptable.

The company has already started signaling it expects
Washington to provide a whopping $7,000 tax credit to Volt purchasers.
In Europe and the U.S., under whatever fuel economy and emissions
regulations prevail, GM also expects special favoritism for the Volt.
The goal is to re-enact the flex-fuel hoax, in which GM receives extra
credit for making cars that can burn 85% ethanol, even if they never
see a drop of such fuel.

CEO Rick Wagoner last week laid out the case to Barack
Obama personally for turning GM into a ward of the state, by way of
direct and indirect subsidies to support a transition to "alternative"
fuel vehicles. GM has done yeoman's work getting its structural costs
(i.e., labor) in line, but shareholders should note that a big part of
the company's turnaround gamble consists also of eliciting favor once
again from Washington after a period in which the domestic auto makers
were nothing but whipping boys on Capitol Hill.

As a followup to my point on oil prices, here are a selection of posts on oil prices and speculation that have caught my eye of late:

McQ writes about the charge of "inactive" oil leases, which Democrats attempted to use as an excuse for not opening up new lease areas for drilling

Tyler Cowen has a big roundup on the topic, with many links, and Alex Tabarrok has a follow-up.  Cowen discusses rising oil prices in the context of Julian Simon here.

Michael Giberson also addresses speculation, while observing that non-industrial buyers have not increased their position in the futures market as oil prices have risen

Don Boudreaux has thoughts on drilling restrictions

Finally, via Scrappleface:

When the U.S. Supreme Court reconvenes on the first Monday in
October, the nine Justices may consider whether the Constitutional
preamble clause "secure the Blessings of Liberty to ourselves and our Posterity" guarantees an individual right to drill for oil.

Now that the court, in a 5-4 ruling on the Heller case, has upheld
the Second Amendment right of "the people," not just state-run
militias, to keep and bear arms, some scholars say the court may be
willing to go the next logical step and recognize the peoples' right to
acquire their own fuel.

A number of readers have written me, the gist of the emails being "you have written that X or Y is NOT causing higher oil prices -- what do you think IS causing high oil prices?"  Well, OK, I will take my shot at answering that question.  Note that I have a pretty good understanding of economics but I am not a trained economist, so what follows relates to hard-core economics in the same way pseudo-code relates to C++.

My first thought, even before getting into oil, is that commodity prices can be volatile and go through boom-bust periods.  Here, for example, is a price chart of London copper since 1998:

While oil prices have gone up by a factor of about four since 1998, copper has gone up by a factor of about 15!  But the media seldom writes about it, because while individual consumers are affected by copper prices, they don't buy the commodity directly, and don't have stores on every street corner with the prices posted on the street.

For a number of years, it is my sense that oil demand has risen faster than supply capacity.  This demand has come from all over -- China gets a lot of the press, but even Europe has seen increases in gasoline use.  Throughout the world, we are on the cusp of something amazing happening - a billion or more people in Asia and South America are emerging from millennia of poverty.  This is good news, but wealthier people use more energy, and thus oil demand has increased.

On the supply side, my sense is that the market has handled demand growth up to a point because for years there was some excess capacity in the system.  The most visible is that OPEC often has been producing below their capacity, with Saudi Arabia as the historic swing producer.  But even in smaller fields in the US, there are always day to day decisions that can affect production and capacity on a micro scale.

One thing that needs to be understood - for any individual field, it is not always accurate to talk about its capacity or even its "reserves" as some fixed number.  How much oil that can be pumped out on any given day, and how much total oil can be pumped out over time, depend a LOT on prices.  For example, well production falls over time as conditions down in the bottom of the hole deteriorate  (think of it like a dredged river getting silted up, though this is a simplification).  Wells need to be reworked over time, or their production will fall.  Just the decision on the timing of this rework can affect capacity in the short term.  Then, of course, there are numerous investments that can be made to extend the life of the field, from water flood to CO2 flood to other more exotic things.  So new capacity can be added in small increments in existing fields.  A great example is the area around Casper, Wyoming, where fields were practically all shut-in in the 1990's with $20 oil but now is booming again.

At some point, though, this capacity is soaked up.  It is at this point that prices can shoot up very rapidly, particularly in a commodity where both supply and demand are relatively inelastic in the short term.

Let's hypothesize that gas prices were to double this afternoon at 3:00PM from $4 to $8.  What happens in the near and long-term to supply and demand?

In the near term, say in a matter of days, little will change on the demand side.  Everyone who drove to work yesterday will probably drive today in the same car -- they have not had time to shop for a new car or investigate bus schedules.  Every merchandise shipper will still be trucking their product as before - after all, there are orders and commitments in place.  People will still be flying - after all, they don't care about fuel prices, they locked their ticket price in months ago. 

However, people who argue that oil and gas demand is inelastic in the medium to long term are just flat wrong.  Already, we are seeing substantial reductions in driving miles in this country due to gas price increases.  Demand for energy saving investments, from Prius's to solar panels, is way up as well, demonstrating that prices are now high enough to drive not only changed behaviors but new investments in energy efficiency.  And while I don't have the data, I am positive that manufacturers around the world have energy efficiency investments prioritized much higher today in their capital budgets.

There are some things that slow this demand response.  Certain investments can just take a long time to play out.  For example, if one were to decide to move closer to work to cut down on driving miles, the process of selling a house and buying a new one is lengthy, and is complicated by softness in the housing markets.  There are also second tier capacity issues that come into play.  Suddenly, for example, lots more people want to buy a Prius, but Toyota only has so much Prius manufacturing capacity.  It will take time for this capacity to increase.  In the mean time, sales growth for these cars may be slower and prices may be higher.  Ditto solar panels. 

Also, there is an interesting issue that many consumers are not yet seeing the full price effects of higher oil and gas prices,and so do not yet have the price incentive to switch behavior.  One example is in air travel.  Airlines are hedged, at least this year, against much of the fuel price increase they have seen.  They are desperately trying not to drive people out of air travel (though DHS is doing its best) and so air fares have not fully reflected fuel price increases.  And since many people buy their tickets in advance, even a fare increase today would not affect flying volumes for a little while.

Another such example that is probably even more important are countries where consumers do not pay world market prices for gas and oil, with prices subsidized by the government (this is mostly true in oil producing countries, where the subsidy is not a cash subsidy but an opportunity cost in terms of lost revenue potential).  China is perhaps the most important example.  As we mentioned earlier, Chinese demand increases have been a large impact on world demand, as illustrated below:

All of these new consumers, though, are not paying the world market price for gasoline:

While consumers in much of the world have been reeling from spiraling
fuel costs, the Chinese government has kept the retail price of
gasoline at about $2.60 a gallon, up just 9% from January 2007.

During that same period, average gas prices in the U.S. have surged
nearly 80%, to about $4 a gallon. China's price control is great for
people like Tang, who drives long distances in his gas-guzzling Great
Wall sports utility vehicle.

But
Tang and millions of other Chinese are bracing for a big jump in pump
prices. The day of reckoning? Everybody believes it's coming right
after the Summer Olympics in Beijing conclude in late August.

Demand, of course, is going to appear inelastic to price increases if a large number of consumers are not having to pay the price increases.

Similarly, there are factors on the supply side that make response to large price increases relatively slow.  We've already discussed that there are numerous relatively quick investments that can be made to increase oil production from a field, but my sense is that most of these easy things have been done.  Further increases require development of whole new fields or major tertiary recovery investments in existing fields that take time.  Further, we run up against second order capacity issues much like we discussed above with the Prius's.  Currently, just about every offshore rig that could be used for development and exploration is being used, with a backlog of demand.  To some extent, the exploration and development business has to wait for the rig manufacturing business to catch up and increase the total rig capacity.

There are also, of course, structural issues limiting increases in oil supply.  In the west, increases in oil supply are at the mercy of governments that are schizophrenic.  They know their constituents are screaming about high oil prices, but they have committed themselves to CO2 reductions.  They know that their CO2 plans actually require higher, not lower, gas prices, but they don't want the public to understand that.  So they demagogue oil companies for high gas prices, while at the same time restricting increases in oil supply.  As a result, huge oil reserves in the US are off-limits to development, and both the US and Canada are putting up roadblocks to the development of our vast reserves of shale oil.

Outside of the west, most of the oil is controlled by government oil companies that are dominated by incompetence and corruption.  For years, companies like Pemex have been under-investing in their reserves, diverting cash out of the oil fields into social programs to prop up their governments.  The result is capacity that has not been well-developed and institutions that have only limited capability to ramp up the development of their reserves.

One of the questions I get asked a lot is, "Isn't there a good reason for suppliers to hold oil off the market to sustain higher prices?"  Well, let's think about that.

Let's begin with an analogy.  Why wouldn't Wal-mart start to hold certain items off the market to get higher prices?  Because they would be slaughtered, of course.  Many others would step in and fill the void, happy to sell folks whatever they need and taking market share from Wal-mart in the process.  I think we understand this better because we know the players and their motivations better in retail than we do in oil.  But the fact is that Wal-mart arguably has more market power, and in the US, more market share than any individual oil producer has worldwide.  Oil producers have seen boom and bust cycles in oil prices for over a hundred years.  They know from experience that $130 oil today may be $60 oil a year from now.  And thus holding one's oil off the market to try to sustain prices only serves to miss the opportunity to get $130 for one's oil for a while.  People tend to assume that the selfish play is to hold oil off the market to increase prices, but in fact it is just the opposite.  The player who takes this strategy reduces his/her own profit in order to help everyone else. 

This is a classic prisoner's dilemma game.  Let's consider for a moment that we are a large producer with some ability to move prices with our actions but still a minority of the market.  Consider a game with two players, us and everyone else.  Each player can produce 80% of their capacity or 100%.  A grid showing reasonable oil price outcomes from these strategies is shown below:

Reductions in our production from 100% to80% of capacity increases market prices, but not by as much as would reductions in production by other producers, who in total have more capacity than we.  Based on these prices, and assuming we have a million barrels a day of production capacity, the total revenue outcomes for us of these four combinations are shown below, in millions of dollars (in each case multiplying the price times 1 million barrels times the percent production of capacity, either 80 or 100%):

We don't know how other producers will behave, but we do know that whatever strategy they take, it is better for us to produce at 100%.  If we really could believe that everyone else will toe the line, then everyone at 80% is better for us than everyone at 100% -- but players do not toe the line, because their individual incentive is always to go to 100% production.  For smaller players who do not have enough volume to move the market individually (but who make up, in total, a lot of the total production) the incentive is even more dramatically skewed to producing the maximum amount.

The net result of all this is that forces are at work to bring down demand and bring supply up, they just take time.  I do think that at some point oil prices will fall back out of the hundreds.  Might this reckoning be pushed backwards a bit by bubble-type speculation?  Sure.  People have an incredible ability to assume that current conditions will last forever.  When oil prices were at $20 for a decade or so, people began acting like they would stay low forever.  With prices rising rapidly, people begin acting like they will continue rising forever.  Its an odd human trait, but a potentially lucrative one for contrarians who have the resources and cojones to bet against the masses and stick with their bet despite the fact that bubbles sometimes keep going up before they come back down.   

I don't have the economic tools to say if such bubble speculation is going on, or what a clearing price for oil might be once demand and supply adjustments really kick in.  I do have history as an imperfect guide.  In 1972 and later in 1978 we had some serious price shocks in oil:

Depending on if you date the last run-up in prices from '72 or '78, it took 5-10 years for supply and demand to sort themselves out (including the change in some structural factors, like US pricing regulations) before prices started falling.  We are currently about 6 years into the current oil price run-up, so I think it is reasonable to expect a correction in the next 2-3 years of fairly substantial magnitude. 

Postscript:  I have left out any discussion of the dollar, which has to play into this strongly, because what I understand about monetary policy and currencies wouldn't fill a thimble.  Suffice it to say that a fall in value of the dollar will certainly raise the price, to the US, of oil, but at the same time rising prices of imported oil tends to make the dollar weaker.  I don't know enough to sort out the chicken from the egg here,

Via Tim Worstall, Gawain Towler reports this bill in front of the European Supreme Soviet Parliament:

Written declaration on fixing fuel prices
The European Parliament,"“ having regard to Rule 116 of its Rules of Procedure,
A.
Whereas we are witnessing an unprecedented rise in fuel prices, and
this scandalous surge is having a devastating effect on economic
activity in various sectors: transport and other services, industry,
agriculture and fisheries,
B. Whereas in Portugal, the major oil
companies in the first quarter of this year, vis-à-vis the first
quarter of 2007, made net profits of 22.9% (GALP), and consolidated
profits of 36.5% (REPSOL) and 63.4% (BP), which were fundamentally the
result of practising speculative pricing, as a result of the
speculative valuation of oil stocks
bought at lower prices,

1.
Calls for the establishment of a tax, for each Member State, to be
levied exclusively on these profits so as to bring them back into the
coffers of the Member State. This tax should be paid within 60 days
after the end of each quarter, with the value and scope of the levy
depending on the readiness of the oil companies to reduce their
speculative gains thanks to the 'stock effect';
2. The revenue
generated by this tax should be returned on a proportional basis to the
various economic sectors in each Member State;
3. Instructs its
President to forward this declaration, together with the names of the
signatories, to the Council, Commission, and Parliaments of the Member
States.

"depending on the readiness of oil companies to reduce their speculative gains thanks to the 'stock effect'"??  What the *&#$@% does this mean?  What economic concept are they even trying to get at?

Further, I was amazed at the statement that BP made net profits of 63.4%.  It took me a while to figure out that this was the quarter over quarter profit growth, not the profit margin.  I can't tell if these guys are just ignorant or if this is a translation issue into English, so i will give them the benefit of the doubt.  In case you are wondering, BP's net profit margin in the first quarter of 2008 was 8.3% of revenues, which in the grand scheme of industry is actually below average.

One reason fuel prices are so high in Europe is because the government takes more than half of fuel revenues in taxes:

Fuel taxes are also the central issue for truckers in Europe, because
they account for a large portion of the retail price of fuel. Unleadedgasoline
sold for $8.65 per gallon and diesel for $9.62 per gallon Tuesday in
Britain, which charges a flat $3.77 per gallon in fuel duty and imposes
a 17.5 percent consumptiontax on the total price

So, 61% (44% from the $3.77 plus the 17.5%) goes to government and 8.3% goes to the BP shareholders.  So lets tax BP shareholders more to lower the price!

Kevin Drum titles a post on providing government incentives for high MPG cars "Ending the Addiction,"  by which I presume he means addiction to gasoline.   I really struggle with the point of view on life that describes consumer affinity for enormously value-producing technologies to be an "addiction."  One could equally well refer to our preference for good health or prosperity to be an "addiction," particularly when fossil fuels have played such a central role in fueling the industrial revolution and the prosperity which it has brought.  With the current jump in oil prices tied so closely to growing wealth in China, never has the tie between fossil fuel use and prosperity been more obvious.

Drum advocates for what he calls a "progressive" proposal:

For cars, the most effective thing would be a "feebate": In the
showroom, less-efficient models would have a corresponding fee, while
the more-efficient ones would get a rebate paid for by the fees. That
way when choosing what model you want you would pay attention to fuel
savings over its whole life, not just the first year or two. It turns
out that the automakers can actually make more money this way because
they will want to get their cars from the fee zone into the rebate zone
by putting in more technology. The technology has a higher profit
margin than the rest of the vehicle.

I will say that this is probably less bad than other "progressive" proposals I have heard, but the logic here is based on consumer ineptness.  Higher gas prices, which drive higher lifecycle costs, are presumably providing exactly this incentive without any government program.  The problem, it seems, is that progressives don't think very much of the common people they wish to defend.  Just as the justification for Social Security is that the average person can't be trusted to make good decisions about their retirement savings so we elites will do it for them, this seems to be the logic here, but even more patronizing.   Here is the best bit which really demonstrates the point I am making:

Here's a further suggestion: require stickers to list the estimated cost of fuel consumption over a five year period.

Basically this calculation is total estimated miles per year divided by mpg times estimated gas prices times five. A simple piece of math with four numbers that can be completed on a calculator in 10 seconds or by hand in less than 30 seconds.  Mr. Drum, a big supporter of our current monopoly government school system, apparently does not think that people educated in this system can do this math for themselves.  Could it be clearer that "progressivism" is really about disdain for the common man and a belief that elites should make even the smallest decisions for them?

A good column on gas prices by George Will.

Can a senator, with so many things on his mind, know so precisely how
the price of gasoline would respond to that increase in the oil supply?
Schumer does know that if you increase the supply of something, the
price of it probably will fall. That is why he and 96 other senators
recently voted to increase the supply of oil on the market by stopping
the flow of oil into the Strategic Petroleum Reserve,
which protects against major physical interruptions. Seventy-one of the
97 senators who voted to stop filling the reserve also oppose drilling
in the Arctic National Wildlife Refuge.

One million barrels is what might today be flowing from ANWR if in 1995 President Bill Clinton
had not vetoed legislation to permit drilling there. One million
barrels produce 27 million gallons of gasoline and diesel fuel.
Seventy-two of today's senators -- including Schumer, of course, and 38
other Democrats, including Barack Obama, and 33 Republicans, including John McCain -- have voted to keep ANWR's estimated 10.4 billion barrels of oil off the market.

We all know that the media is perfectly capable of ignoring even the most basic precepts of economics, but I thought Chris Plummer's article was especially heroic in doing so.  Even more so, it is absolutely stunning in its arrogance.  In his article, he writes on all the great ways that $8 a gallon gasoline will help make the world a better place.  I will stay away from the global warming related issues -- I have a whole other blog dedicated to that -- but here are a couple of the most egregious parts:

They may contain computer chips, but the power source
for today's cars is little different than that which drove the first
Model T 100 years ago. That we're still harnessed to this antiquated
technology is testament to Big Oil's influence in Washington and
success in squelching advances in fuel efficiency and alternative
energy.

   
       

Given our achievement
in getting a giant mainframe's computing power into a handheld device
in just a few decades, we should be able to do likewise with these
dirty, little rolling power plants that served us well but are overdue
for the scrap heap of history.

OK, this first one is a science problem and not an engineering problem.  Here is the problem:  Gasoline contains more potential energy by weight and volume than any power storage source we have been able to invent (OK, its actually second, nuclear fuel is first, but I presume Plummer is not going there).  That is the problem with electric cars, for example.  Electric traction motors are demonstrably better sources of motive power than internal combustion engines.  Even Diesel railroad engines are actually driven by electric traction motors.  The problem is energy storage.  Batteries store much less energy per pound and per cubit foot than gasoline.  Ditto natural gas and hydrogen (except at very high pressures).

This claim that only the political power of oil companies keeps no-brainer alternative technologies at bay is absurd, though it is one that never dies in the lunatic fringes.  Mr. Plummer is more than welcome to make himself a billion dollars by selling one of these mystery technologies he fails to disclose.  I will be first in line to buy.

Necessity being the mother of invention, $8 gas would trigger all
manner of investment sure to lead to groundbreaking advances. Job
creation wouldn't be limited to research labs; it would rapidly spill
over into lucrative manufacturing jobs that could help restore
America's industrial base and make us a world leader in a critical
realm.

This is the broken window fallacy on steroids.  I am a HUGE optimist about the limitless capabilities of the human mind, probably more so than Mr. Plummer (by the way, if he is such an optimist, he should read some Julian Simon).  But the best that humanity can probably do any time soon is offset a goodly percentage of the damage from $8 gas.  There is no net win here.  If there were, he should also be advocating $10 bread, $2,000,000 starter home prices, and $200 a month internet service.  Just think about all the innovation that would be required to react to these!

On a similar note, Venezuela's Hugo Chavez and Iran's Mahmoud
Ahmadinejad recently gained a platform on the world stage because of
their nations' sudden oil wealth. Without it, they would face the
difficult task of building fair and just economies and societies on
some other basis.

Yes sir.  Chavez would be much worse off if he was getting $8 for his gas rather than $3.  What is this guy thinking?  Well, he says this:

In the near term, breaking our dependence on Middle Eastern oil may
well require the acceptance of drilling in the Alaskan wilderness

OK, but that can be done at $3 gas,and should have been allowed at $2 gas.  This oil could have been developed in an environmentally friendly way years ago.  Only Congressional stupidity stands in the way  (probably with the past support of Mr. Plummer).

The recent housing boom sparked further development of
antiseptic, strip-mall communities in distant outlying areas. Making
100-mile-plus roundtrip commutes costlier will spur construction of
more space-efficient housing closer to city centers, including cluster
developments to accommodate the millions of baby boomers who will no
longer need their big empty-nest suburban homes.

   
       

Sure, there's plenty of
land left to develop across our fruited plains, but building more
housing around city and town centers will enhance the sense of
community lacking in cookie-cutter developments slapped up in the
hinterlands.