Gasoline: $12 Dollars/Gallon Inevitable
According to this article, Charles T. Maxwell is predicting that gasoline will eventually reach $12-$15/gallon. Why the pessimistic forecast? Many analysts believe that we are in a period where oil production is going to decline, and yet demand is increasing. The obvious result is higher prices of oil, and thus gasoline.
“[T]he prices that we’re paying at the pump today are, I think, going to be ‘the good old days,’ because others who watch this very closely forecast that we’re going to be hitting $12 and $15 per gallon,” Hirsch said. “And then, after that, when oil — world oil production goes into decline, we’re going to talk about rationing. In other words, not only are we going to be paying high prices and have considerable economic problems, but in addition to that, we’re not going to be able to get the fuel when we want it.”
“[Maxwell] expects an oil-induced financial crisis to start somewhere in the 2010 to 2015 timeframe,” Energytechstocks.com reported. “He said that, unlike the recession the U.S. appears to be in today, ‘This will not be six months of hell and then we come out of it.’ Rather, Maxwell expects this financial crisis to last at least 10 or 12 years, as the world goes through a prolonged period of price-induced rationing (eg, oil up to $300 a barrel and U.S. pump prices up to $15 a gallon).”
This prediction seems overly pessimistic to me. At $12/gallon a person who fills up a 12 gallon tank once a week is going to be spending about $5,000 more per year than if the price were $4/gallon. At such a point, switching to a hybrid would make economic sense so long as the hybrid’s higher cost was under that $5,000 differential. Further, the technology for hybrids and other solutions will continue to advance, and in fact might accelerate. After all, with gasoline and oil prices rising at such a rate someone finding an alternative for oil in some of the products that use oil would stand to reap a not insubstantial windfall. In other words, we not only see an income effect, but also a substitution effect.
The potential problems are political busybodies who inject themselves into the market process because they think they can make decisions for a large number of people better than the people themselves. This can lead to bad incentives that actually exacerbate the problem, not make it better. For example, if oil and gasoline prices go up because of increased demand, trying to keep prices low wont solve the problem, it will simply make the problem worse.
Prof. James Hamilton suggests that there might be a bubble in oil prices that could be contributing to the current high prices. To the extent that the recent run up in prices are the result of speculation and if they are part of the basis for forecasting $12 to $15/gallon prices then that forecast might be overly pessimistic. Still, if the actual price turns out to be $10.50/gallon that is quite an increase. Charles Engel also weighs in on the possibility of an oil bubble here. And let me be clear, even if there is an oil bubble it doesn’t mean oil prices are going to drop to some low level like $60/barrel. But Engel provides one reason to think the idea of $300/barrel by 2010 or even 2011 or 2012 is overly pessimistic,
I can understand why market fundamentals make the price of oil high — but why is it rising? Let me explain this question. Oil is a durable, storable commodity. If the increase in excess demand is expected by the markets, it should be incorporated in the price immediately. That is, if the markets have understood for some time that rising demand from emerging markets was squeezing the market for oil, the price should have jumped immediately to reflect those expectations. If markets expected rising demand four years ago, and could calculate that the price would be $120 today, then the price should have been a lot higher than $40 back then. Anyone who bought a barrel of oil in 2004 would have made a 200% return over those four years. But in anticipation of $120 oil prices in 2008, markets should have bid up the price back in 2004.
The same logic applies today. Suppose you have good reason to expect prices to be $300/barrel in June of 2012 (the mid point in Maxwell’s prediction time frame above). If you bought as much as you could now and stored it till 2012 (about 4 years) you’d earn over 222% return on your investment. Even accounting for storage costs you’d make a killing. This kind of incentive would push up the price right now. We aren’t seeing it so most investors don’t believe Maxwell’s prediction.
But you say, “Yes, but as Engel points out we did go from $40 to $120 going from 2004 to 2008, so why can’t it happen again?” Well it could. The point Engel is making is that based on the fundamentals back in 2004 nobody expected this price. This price increase was unexpected—i.e. a low probability event. I’d argue similarly with the Maxwell prediction. The price could still end up at $300/barrel, I just don’t think it is likely at this point in time.