Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Sunday, September 04, 2005

Oil and Refining Capacity;
a shock waiting to happen

By now, most people know that the impact of Katrina on oil supplies and oil prices was not very substantial, relative to the relevant market -- the world market for oil. I even shook my head in disbelief when I read that the US federal gubmnt was planning to release some oil from its strategic reserves, and that other countries have promised to so, too, as if that do much to affect the markets.

The major impact of Katrina in the energy markets has been (and will continue to be) on gasoline and heating oil, not on crude oil. The reasons are well explained in this NYTimes article [reg. req., thanks to Sean and JJ].

No new refinery has been built in the United States since 1976. Over the last quarter-century, the number of refineries has fallen by more than half, to 149. Some, but not all, of that capacity has been made up by expanding or improving existing facilities. Refining capacity has declined by 10 percent, to 17 million barrels a day.

Over the same period, however, gasoline consumption has risen by 45 percent, to 9.5 million barrels a day. Domestic consumption of oil, including that used to make gasoline, is more than 20 million barrels a day.
Disruption to 25% of the US refining capacity, and destruction of some of it, means that even if the US had lost no oil pumping ability, there would be large price increases for gasoline and heating oil. If, indeed, the price elasticity of demand for gasoline is 0.7, prices will have to rise by more than 30% above the pre-Katrina levels, and stay there for some time, to clear the market.

Update: For more on the implications of these price hikes, see this item in the WSJ. It says 10% of refining capacity was lost; thus if the price elasticity of demand for gasoline is .7, then the price will have to rise by only about 14%; that's plausible if the elasticity is a longer-run measure.

How long prices will stay that high depends on several factors:

  1. How long will how much refining capacity be disabled?
  2. How much refined gasoline and heating oil can be purchased internationally?
  3. To what extent are gubmnt bureaucrats gonna mess with the market system?

This last point, sadly, is missed (as seems typical) by the NYTimes:

Still, with no government control over either prices or supplies - and despite the global emergency coordination, the pledges of rising European imports and the loans from American strategic stocks - the risks to oil markets remain very high, analysts and economists said.

I don't believe this. I would like to see the names of the economists who said this. One thing has become very clear over the past forty years: the risks to oil markets are higher when gubmnts try to control them.

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