Gas Price History Lesson: Drop in U.S. Drilling & Rising Energy Costs
by William O'Keefe
March 26, 2012
An AP “Fact Check” released earlier this month claimed that domestic drilling doesn’t drop gas prices, stating:
A statistical analysis of 36 years of monthly, inflation –adjusted, gasoline prices and U.S. domestic oil production by the Associated Press shows no statistical correlation between how much oil comes out of U.S. wells and the price at the pump.
This analysis-come-editorial confirms Mark Twain’s observation that “if you don’t read the newspaper, you are uninformed; if you do read the newspaper, you are misinformed.” The AP attempts to use a disconnected statistic, domestic production, to make an erroneous correlation to counter arguments in favor of more U.S. exploration and development. In doing so, the wire service offers the public a political statement in place of objective analysis.
To begin with, domestic oil production has been steadily declining since its peak in 1970 when it averaged 9.64 million barrels per day (MMbbl/d). From 1978 to 2010, domestic production reduced 37 percent. In that same period, the price of gasoline increased by nearly 60 percent—climbing from a national average of $1.61 to 2.56 per gallon.
This data seems to suggest what many of us already learned in ‘Economics 101’; there’s an inverse relationship between supply and demand. That means that as the availability of a product/service (ie. oil, wheat, gold, etc.) declines, prices will rise.
The AP even concedes this point mid-way through the story, noting “if drilling activity rises around the globe for a sustained period of time, gasoline prices can fall as that new supply eventually finds its way to market.” Yet, it then implies that crude oil prices are insensitive to changes in supply as if it is a unique commodity. The story ignores what has happened to prices when for example a hurricane disrupted production and refining in the Gulf coast region, or when Nigerian or Libyan oil production has been disrupted. The price of crude goes up and then down when supplies come back on line. So when other factors are relatively stable, an increase in supply relative to demand will lower price. How much depends on the increase in supply.
The point being made by those who connect the Obama energy policy to rising gasoline prices is not that other factors are unimportant but that a policy of NO and a self imposed moratorium on increased exploration has probably resulted in hundreds of thousands of barrels or more not being produced. Adding those unproduced barrels to the current global supply would put downward pressure on crude oil prices which translate into to lower gasoline prices. Instead, there has been a policy of NO to the eastern Gulf of Mexico, NO to offshore drilling, NO to Alaska’s coastal plain, and NO to Keystone XL. With a more enlightened energy policy our oil production over the course of this decade could increase by a million barrels a day or more. That is not trivial.
Saudi Arabia has pledged to increase its production to reduce the price of crude oil. If we had been more aggressive with our domestic activity, it might have encouraged the Saudis and others to increase theirs to protect their market share. The result would have been the same, more supply, lower price.
While politicians and the media have focused on the price of crude oil which accounts for about 80% of the price of gasoline, the effects of regulatory burdens have been largely ignored. Since 2010, four east coast refineries have closed because they were no longer profitable. The destruction of profitability has been partly caused by the inability to pass through the full cost of crude oil but also by large regulatory burdens, for which there is no end in sight.
EPA’s greenhouse gas regulation, its proposed Tier III gasoline rule, new source performance standards, boiler MACT, and proposed NAAQS will lead to less refining capability and higher prices. In the case of the East Coast, more gasoline will end up being imported from Europe where the price of crude oil is much higher than our domestic crude. Excessive regulatory requirements that don’t produce commensurate environmental benefits are wastes that produce unintended consequences.
In the short term, there is very little that the President or Congress can do to reduce gasoline prices. Unfortunately, today’s prices are the result of actions not taken over in past years. The path to lower prices in the future is more supply, a stronger dollar, a stronger economy which would encourage traders to shift their bets from crude oil to other investments, and a rationalization of regulations.