TL;DR
High energy prices are the result of global market issues exacerbated by the desire for “green” policies by the Davos class. They are not the result of “Big Oil” price gouging – it’s not clear that “Big Oil” would even want prices this high, and the presence of a broad market at each stage of production of gasoline/diesel means that they couldn’t force them up even if they wanted to.
The first part of the essay is largely well-known; skip to the less well-known information here.
Background
As I write this (middle of 2022), USA version 1 (and, indeed, much of the world), is in the throes of economic misery, largely brought on (at least here) by a couple of factors:
- Monetary policy: An orgy of government deficit spending (beginning in 2009 in the US*) whose inflationary “chickens” are finally coming home to roost (recall: “Inflation is always and everywhere a monetary phenomenon” – Milton Friedman). Note that, in the two graphs below, moderate deficits seem not to affect the money supply significantly, but once we broke the $500B barrier (or maybe the $1T barrier, since those happened at the same time), the effect was striking. Deficit impacts money supply which impacts (with a time lag) inflation.
- Energy policy: The USA version 1 Federal government (specifically the Biden administration) joining with many of the other governments of the world to drive down oil (and other fossil fuel) production in the name of opposing “climate change.” In the US, this took the form of cancelling pipelines, slow-walking drilling permits, forcing refineries to convert to biodiesel production, demonizing and threatening fossil fuel industries, etc.
The focus of this essay is specifically the second of these inflation-driving policies (high energy prices), rather than the first (though the first is bad enough, and may in fact be harder to unwind than the second).
Full disclosure: although this is not normally the case, I do actually have some modest energy company investments in my personal portfolio at the moment (with a 12-30% loss). However, I have certainly said all the things I’m saying here at times when I didn’t have a dog in the fight. My energy stocks truly have nothing to do with this essay; they’re not even the biggest Biden-administration whipping boy in my portfolio – the current administration is an equal-opportunity destroyer of value.
How do energy prices affect economics?
Higher energy prices reduce economic growth. It turns out to be somewhat difficult to find clear data supporting this proposition since it is as close to “self-evident” as one gets in economics. There are studies like this from the CBO looking at secondary factors (reasons that the large 2003-2006 increase in crude oil price was less economically damaging than the similar one in the 1970s), but the basic fact is so clear that it is rarely examined in detail.
Energy prices are a significant component of the cost of:
- nearly every transaction (transportation),
- labor (“cost of living” of laborers),
- workplace productivity (climate control),
- industrial production (factory costs, as well as input production costs),
- food (agricultural fuel, fertilizer inputs, as well as processing, transportation and refrigeration costs),
as well as many other incremental costs of production.
This is clearly true in modern, developed economies (moderate energy prices are necessary to sustain expected levels of economic growth), but perhaps even more true in developing economies (see, for example, here where Stern demonstrates the [perhaps unsurprising] result that growth is more energy-constrained in scarce-energy economies than in energy-abundant ones).
To intentionally drive up global energy costs (as so-called “green” policies do) is to immorally condemn citizens of developing countries (and some in developed countries) to continued (and even worsening) poverty.
How does economics affect energy prices?
I would guess that the preceding would be fairly well-understood by most of the American public. They certainly understand the huge impact on their personal bottom-line when energy prices go up! In informal discussions with my compatriots, though, the following question seems to be less well-understood: what economic forces cause higher gasoline prices at the pump, or higher electric prices? Is it the result of some sort of price-gouging by the people to whom we pay those higher energy prices?
To understand this a little better, imagine that you are the CEO of one of the “Big Oil” companies (actually, they are all “energy companies” more broadly now, and fund much of the research into fossil fuel alternatives as well, but let’s set that to one side for the moment). Let us further imagine that you have magical power over time and space – do you want the price of oil to go up or go down?
We Texans tend to understand the “all bidness” better than most, but even in Texas a correct answer to this question is surprisingly elusive. Consider the overall process of bringing diesel or gasoline to your neighborhood service station. Roughly speaking, the steps are:
- Oil exploration (including lease acquisition)
- Oil drilling
- Oil production
- Crude transportation
- Refining
- Fuel transportation
- Retail
The Big Oil companies are involved at each stage of this process (they are vertically integrated companies). However, this fact can easily lead to a misunderstanding: the fuel sold at, say, an Exxon service station does NOT come (entirely) transported by Exxon trucks, refined at Exxon refineries, transported by Exxon crude transport, produced by Exxon wells, drilled by Exxon drillers, found on land with mineral rights owned by Exxon. Instead, at every stage of the process, there are MANY companies involved with various complicated relationships to the “Big Oil” companies, and neither the inputs nor the outputs of any Exxon-controlled process stay entirely within the company. Exxon-owned exploration may result in mineral rights purchases, or in a royalty arrangement with landowners; Exxon-owned drilling may be done on land with a variety of owners (and royalties are owed to landowners whose rights are geologically-related to the field being drilled, even though the well may not be located on their property); Exxon-owned production may be done on a well drilled/explored by themselves or any other drilling/exploration company; Exxon-owned crude transportation may be from a well owned by anyone and to a refinery owned by anyone; Exxon-owned refineries refine crude provided by anyone and supply in turn a variety of retailers, with a variety of transport as an intermediary; retail outlets are mostly locally owned with marketing agreements with the various “Big Oil” brands (on the main intersection in my small town, there is both an Exxon station and a Mobil station, despite the fact that those two companies merged in 1999 – I’m pretty sure neither station is actually owned by ExxonMobil; furthermore, fuel retailers make pennies on the gallon on fuel: the real money is in snacks!).
So, what’s the upshot of all this complication? At each stage, the “Big Oil” company gets paid for the service provided (exploration, drilling, etc.) but some of the services (refining, transportation, retailing) are priced by the barrel or gallon, more-or-less independent** of the price of oil; others (exploration, drilling, production) tend to have prices that track with the price of crude oil. Furthermore, the fact that each stage has market-driven inputs and outputs means that no individual company can possibly change prices for their service without the market forcing them back to the market level.
This means that high oil prices (and consequently high gasoline/diesel prices) benefit the exploration, drilling and production stages; low oil prices (and thus higher consumption) benefit the transportation, refining and retail stages.
So, back to my original question: if you are the CEO of a “Big Oil” company, do you want crude prices (and thus diesel/gasoline prices) to go up or down? The answer is, “you don’t care, as long as you know in advance.” As long as price trends may be accurately forecast, appropriate commodity hedges and contracts can be employed so that the “Big Oil” company will do fine, no matter what the price of oil does.
The fact that the “Big Oil” companies have been doing more-or-less OK in the sky-high oil price regime that we are in at the moment (mid-2022) is NOT because they are evil price-gougers (which they couldn’t do anyway because of all the market forces involved at every stage). Rather, it’s because every country in the developed world is now ruled by people who are either in or held captive by the Davos crowd (who want high energy prices to facilitate their green dreams) – a drunk monkey could correctly predict high (and rising) oil prices with the current “ruling class” in charge.
If the Biden administration truly wishes to bring down energy prices (as they now say, contrary to earlier statements), they might want to listen to the actual energy producers. It’s just a thought.
* To be clear, though the Trump administration was far better on many policy issues than either the Obama or Biden administrations, deficit spending (and the concomitant “Zero Interest Rate Policy“) is an area where Trump followed right along with the Democrats on either side of him.
** the slight complication here is that some of these (specifically refining and transportation) are also significant consumers of refined fuel, and thus higher fuel costs do affect their per-unit costs and prices (though not, typically, their per-unit profit, so the broader point still stands).