What’s up with the price of gas?

Henry Thompson

Oil prices ranged from $150 to $35 per barrel during 2008. The spike and collapse in the price of gas is due to restrictions on refineries, strains on the delivery system, collapsed demand with the recession, and uncertain government policy.

Contrary to what some political groups might want you to think, the world is not running out of crude oil any time soon. It never will if markets are left alone. As the price of oil increases over the decades it will simply be used less for fuel. Without government interference, the price of oil will continue to rise over the decades although by a few percent annually rather than at the rate seen during the first half of 2008.

Optimal depletion by owners of oil in the ground implies proven reserves would only be half depleted after a century. Meanwhile, the price would triple based on a normal return above production costs. This scenario is based on market forces that ultimately override poor economic and energy policy.

Production costs are as little as $5 in some areas of the world to bring oil to the surface and under $30 everywhere at present. Owners of the oil in the ground make a profit when the price is higher but the price tends to fluctuate. Temporary profit is offset by high exploration and development costs to bring more oil to the surface. Potentially there is oil with higher production costs that will be profitable as the price rises.

Even if no new reserves are found and consumers do not respond to rising prices there is 120 years of proven reserves. That is 12 decades, hardly cause for alarm. Current consumption is about 25 billion barrels and proven reserves are about 3 trillion barrels. Potential reserves are much higher and entire regions of the globe have not been explored for political reasons as well as technical reasons. Political issues can change and technology is constantly improving.

One long term problem is that governments now own most of the oil in the ground and typically spend their profit without investing wisely in capital or new resources. Government owners of the oil in the ground are generally short sighted wasteful autocrats, lacking any efficiency motive to minimize cost. Simply put, a good deal of the revenue from selling oil is wasted.

The spike in the price of oil during 2008 was due to political constraints on production and exploration as well as increased demand from China, India, and other developing countries. There have been no new refineries built in the US for over 30 years and exploration has been curtailed by legislation. The problems with oil are all above ground.

A higher price of gas forces households and businesses to change habits and become more fuel efficient. Fuel costs were similarly high during the 1970s and cars became much more fuel efficient. It will always be possible to substitute labor and capital for fuel when fuel prices are high.

While the decades of cheap fuel are numbered, the increase in the price would be gradual and lead to improved technology if markets are allowed to operate freely.