Updated: Mar 11, 2022
We’ve seen rampant inflation and skyrocketing gasoline prices. Republicans blame the increase on Joe Biden; and Democrats blame the increases on Vladimir Putin. As an energy efficiency engineer for most of my life and now a business coach for energy efficiency companies; I pay close attention to energy and economies. I hate it when politicians use energy to spin a fake narrative. Both sides are doing it. Let’s set the record straight.
Oil & Gas Prices - Reality Check
The COVID19 Pandemic & Our Reaction
In March 2020, we decided to lock the world economies down, in hopes of stopping the spread of a deadly flu virus. The result of this shut down created a large reduction in productivity. We then decided to inject trillions of dollars of cash into these low producing economies to give people a means to survive during the lockdowns. Few warned, this would create economic calamity of sorts. Even more believed the lockdowns were worth it to save lives.
I’m not judging this reaction except to say that we are now paying the price. The three prices that appear most evident are: 1) housing costs; 2) food costs; and 3) gasoline prices. Let’s focus on gasoline.
Gasoline & Crude Oil
As you can imagine, gasoline prices rely heavily on crude oil prices. You can see in the chart below that crude oil is approximately 56% of the price of gasoline. As crude oil increases in price, so does the price of gasoline.
What is driving crude oil prices?
The price of crude oil is based mostly on supply and demand, like anything else in a free market. It is also based on speculation of oil commodity prices, like anything in a commodity market.
Let’s consider how this works in the housing market. Let’s say that your neighbor lists their house for sale for $300,000. You’re surprised by the frenzy of activity when your neighbor gets 10 competing bids, and sells their house for $350,000. You decide you want to sell your house. You list your $300,000 house for $350,000 and get 5 competing bids and sell your house for $375,000. People say that you gouged the buyer. After all, you sold them a $300,000 for $375,000. However, you are responding to a natural supply and demand mechanism in the housing market.
The crude oil market is the same. In the pandemic response, we had way too much oil. Commodity traders saw this drop and tried to unload oil futures as quickly as possible. The drop was so rapid that oil futures went negative. The same happened with many stock prices. Both markets rebounded as speculators realized that they had overreacted. In the meantime, oil producers across the globe dropped their production rates to adapt to the low demand during the pandemic.
In 2021, proven vaccines were in place, unemployment was running out, and people got back to work. With the increase in economic activity, the demand for gasoline; and thus crude oil was increasing more rapidly than production. This created a “temporary” low supply vs a high demand. As with the March 2020 crash, commodity traders drove up the price of oil future contracts.
When we want oil prices to drop, we beg oil companies to produce more oil. They will oblige because producing more oil is profitable in a high price environment. They are reticent to over produce because they'll be stuck with cheap oil.
Sanctions on Russian Oil
The good news is that on a worldwide basis oil production caught up with oil demand (March 2022). The bad news is that Vladimir Putin invaded Ukraine; and western nations are placing sanctions on Russian oil which creates a lower world supply for those who impose those sanctions. As you can imagine, those who do buy Russian oil will get bargains for the same reason we all got bargains on oil when we locked down during the pandemic.
Let’s consider how this would work with our housing analogy. The housing market is hot. Every $300,000 homeowner is selling their house for $375,000. The entire U.S. decides they will stop buying homes in a specific city. Let’s say Los Angeles. If you live in any other state besides California, you stop buying Los Angeles homes. However, local Californian’s can and will buy Los Angeles homes. The prices of Los Angeles homes drop. Californian’s get a bargain to buy a house in Los Angeles. Other home buyers in the rest of the world will pay more for a home in other cities because they have limited their supply of homes to purchase. Californians can buy a house in L.A. for $250,000; while you will pay $400,000 to buy a house in any other city. You can see how sanctions tend to punish both the sanction maker and the sanction receiver; and favor the sanction breaker.
Speculators & Prices
You will hear it said that prices are being driven up or down by speculators. It is true that speculators drive prices up and down. Ultimately, there has to be a supply and demand gap for the price to stay up or down.
If you want to see an example of speculation, you need look no further than Bitcoin. Bitcoin’s chart shows how speculators think about the value of Bitcoin. In the case of Bitcoin, the only demand for Bitcoin is a trader who wants to buy it when the price is low and sell it when the price is high. At present, few merchants accept Bitcoin as payment, and so there is no actual demand for Bitcoin as a currency. If inflation runs amok, government currency becomes worthless, Bitcoin may be worth the speculation.
How does this relate to oil prices? Like Bitcoin, speculators want to buy oil futures at a low price and sell them at a high price. They have no other interest in the market. When world events happen that can impact that price, speculators overreact. This was evident in the pandemic response. Speculators drove the price of crude oil down to -$37 per barrel when the supply/demand value was closer to $50 per barrel.
A wise speculator would have sold oil futures until the price was $50 and then started buying below that price. While speculation can drive a temporary price fluctuation, it’s never responsible for long term prices of a commodity like oil.
Now for the political spin. I hope that you understand how oil and gasoline prices are determined regardless of your political persuasion. Both sides use rhetoric to persuade their adherents.
Republicans receive large donations from oil companies and lobby for more oil exploration. Ironically, oil companies profit during low supply periods for the reasons I’ve explained. Republicans believe they can get more votes blaming gasoline prices on the current administration because high prices create financial pain for most Americans. Republicans claim that we’d have better prices if we approved the Keystone XL pipeline. They say that Joe Biden has unfairly restricted oil companies and that’s why we’re paying more for gasoline.
Democrats receive large donations from environmental activists. They claim that oil companies are opportunists gouging Americans during a time of crisis. The Biden administration is advocating releasing emergency oil reserves to reduce the high price of oil and thus gasoline. Democrats are blaming Vladimir Putin for our oil price woes. If they blame the pandemic, they’ll be called hypocrites as many Democratic governors and politicians advocated for pandemic lockdowns. In the meantime, Democrats have ambitions of creating a clean energy world where we don’t rely on dirty fossil fuels. This, they say will end problems with high gasoline prices as everyone will be driving a clean electric car.
Energy Lies We Tell Ourselves
As you can imagine, both political parties offer elements of truth. But both parties exaggerate to win votes of party loyalists.
I promised you “straight talk”; and that’s exactly what I plan to deliver. Energy is vital to our world economy. Exploration and generation of energy can comprise the health of our planet. Neither objective can be given a higher value than the other.
The Promise of Renewable Energy
I like the idea of creating clean electricity from the sun or the wind… and then using electric appliances and cars to consume this new and clean energy source. The advantages seem clear. Lower carbon emissions: and an energy source that isn’t controlled by the evil dictators of the world.
At our current pace of converting 0.5% our infrastructure to a renewable/electric future per year will make us 100% renewable/electric by 2406 (184 years from now). If we ramp up production and use of electric cars today, we are stressing out our current electric grid; and consuming more dirty and expensive electricity generation.
The Reality of Fossil Fuels
Like it or not, we need fossil fuels. The hope that we can displace fossil fuels by being mean to oil companies is dangerous. It is dangerous to stop domestic production in favor of imported oil. It is dangerous to drive up prices of fossil fuels in hopes that expensive fossil fuels will convince Americans that we need more renewable energy. The danger is evident in how these actions have enriched and encouraged despots in our world. While we cut off oil from Russia, we decide to buy oil from Venezuela. We stop buying from one dictator, only to buy from another dictator.
The Energy Information Association has predicted that crude oil demand will increase at a rate of 3% per year in the near term. This means that while we strive toward a clean energy future, we must respect our current need for fossil fuels. To do anything else would be “willfully ignorant”.
Futility of World Consortiums
Whether it’s called “The Green New Deal” or “Paris Climate Agreement”, these organizations are rarely successful at implementing “real” change. The chart below shows how ineffective each agreement has been in limiting greenhouse gas emissions. Countries promise to reduce emissions. They sign an agreement to penalize their citizens for any environmental infractions. And yet, CO2 levels continue to climb because they have ignored the balance between environment and economy. We are lying to ourselves, if we think these agreements will accomplish any good.
Where do we go from here?
As messed up as our energy future appears, I do believe we have made strides in the right direction.
Develop Electric Technologies – It’s right to continue to march toward electric technologies that will take advantage of multiple generation resources in our future. I believe we can create an electric infrastructure and electric microgrids to utilize whatever energy source we deem most beneficial to our environment or economy. Such flexibility will eliminate hostage taking by oil companies and despotic dictators.
Renewable Energy Infrastructure – Let’s continue building renewable energy infrastructure that makes sense. We need to honestly assess the environmental and economic impact of renewable energy compared with alternatives. While 100% renewable seems out of reach in the near term, I do believe it is a worthy goal if we achieve that goal without compromising logic.
Nuclear Energy – Since the Three Mile Island nuclear meltdown, nuclear energy electricity generation has been considered taboo in the U.S.. There is no question that nuclear electricity generation has environmental cons. However, if we balance the cons with our CO2 emissions, I believe we are much better off building more nuclear plants than not. Nuclear generation creates no CO2 emissions; and is a viable energy source given our abundance of uranium reserves in the U.S.
Adapt to the Climate – Pretending that our climate will never change is “willful ignorance”. I’m not picking a side on the Climate Change Debate. Our climate is changing. We are causing that change to some extent. However, the notion that we can force our world’s climate into obeyance is impractical. This means that we must plan for the climate to change. This is not a bad idea regardless of the cause of climate change. Let’s maintain our forests, improve water storage, plan for modest sea level increases, create emergency response plans for natural disasters and adapt to the weather that comes our way.
Stop Corporate Welfare – We now give grants for green energy projects; and give tax breaks for oil exploration. While these gifts are gladly accepted by their recipients, they are unnecessary to drive right energy policy. Whether it’s the Keystone XL pipeline or another grant for a solar company, this government interference is unnecessary and ineffective in motivating the best energy behavior. Government’s job is to protect the environment and protect domestic trade. Environmental regulations can be levied without corporate welfare. If another country is following improper trade practices, we can impose high import taxes to protect domestic production. This goes for production of renewable energy equipment as much as it applies to oil exploration.
Energy Conservation – Energy prices are volatile, and high energy consumption impacts our environment regardless of its source. The best way to win in both areas is to avoid wasteful consumption of energy. Whether it’s your home, your office, or your factory, I highly recommend that you seek out an Energy Service Company or ESCo to audit your facility to help you find ways to reduce energy consumption. Let’s face it, we need to use energy in our modern lives. Why use more than you need?
I’ve tried to be even-handed and honest. I believe it is vitally important that we get this right and stop our political bickering. If we can do this, I believe we have a bright energy future.