Opinion, Scenario Planning, Strategic Thinking

Are rising gasoline prices due to lower demand?

A recent article in BusinessWeek, “Rising Gas Prices mot Demand-driven” makes the case that lower demand for gasoline is the culprit causing the recent price to climb. Now that is counterintuitive to all those that studied economics of supply and demand. Microeconomics teaches that when demand drops, prices should drop.

Looks like higher prices are caused by the “crack spread”, the cost for refineries to buy the oil, crack it into petroleum product, and sell it. Refineries are apparently closing down, due to the economics of the crack spread, which pinches the supply side of the equations and keeps prices high; and in fact is driving them higher. The current predictions are that the US will see $4 per gallon by May at a time we are using less. This argument implies that the economic constraints within the petroleum market are now working counter to supply and demand. Or more serious, the market economic model for petroleum is broken.

What are some implications?

A very disturbing scenario is $4 per gallon is considered by some industry watchers as the place where the national economies can stall – the price for energy reaches such a high cost that manufacturing, travel, and power production are negatively affected, reducing or reversing the recovery underway.

Another more troubling scenario is that Petroleum manufacturers are creating their own price points by restricting supply (closing refineries) and thus elevating prices. We can be sure that a case will be made that they are “artificially” keeping prices high to make sure profits remain high.

The net result of $4 gasoline is that demand will continue to drop, setting off another round of counter to supply and demand economic price increases. If energy is indeed market-driven, then we may be seeing fundamental changes occurring in the petroleum sector that will have cataclysmic and rapid changes on how the US public views and consumes energy.

The implication for broad sectors of the economy – automotive, alternative fuels, manufacturing – are clear. If these sectors follow observed historical trends when facing sharp increases in petroleum pricing, we can expect a rapid movement to high fuel mileage vehicles, demand for more domestic drilling, and growth in alternative energy production. This cyclic dance has been going on since the OPEC shockwave in the 70’s. Prices go up, people make consumption changes to reduce demand. Alternative energy sources start a mini-boom. Then prices “miraculously” go down. But if the “crack spread” has in fact shifted and the economics of refining petroleum has changed, we will not see prices below $4 as a consequence of reduced demand. Pricing will continue to rise in the face of falling US demand.

A lack of a consensus on a national energy policy, and the ongoing politicization of the issue, has prevented objective dialogue and discussion on the US supply and demand for petroleum. Cheap energy is and always has been, the main driver of the US economic miracle. Expect turmoil, rapid price increases, and gas-bag punditry on the solutions. You should be use to it by now. What you shouldn’t expect is a rational discussion or national policy aimed at keeping America competitive by transition from a petroleum-based economy to an economy that can sustain itself for another century or two.

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