Solve the Energy Problem?

Macroblog has a post on solving the energy problem and points to Andris Piebalgs “plan” to solve the problem. In short the plan is: Increase Refining Capacity. Personall I think this will do nothing. The problem is that when you have a small number of refiners they have an incentive to keep production near the level of “just sufficient”. Building additional capacity is actually not good for profits. But even if we could induce the refiners to add capacity I don’t think it would do all that much.

For example, suppose we have 5 refiners and each refiner can produce upto 21% of the gasoline demanded. That is there is 5% excess capacity. So you order each firm to increase capacity by an additional 3%. This still would not be sufficient to reduce prices and/or volatility of prices. Because if one refinery shuts down the remaining operational refineries would have only enough capacity for 96% of the demand. Even if each refinery increased capacity so that each could in theory meet 25% of the demand, if one firm shuts down, that would leave only 4 and those of use who have suffered through industrial organization know that this would likely increase prices.

What needs to happen, in my view, is that we need not only more capacity, but more competition–i.e. more firms. The reason there are so few firms are the very politicians that are supposedly coming up with the plans to get us out of this mess. Environmental laws on emissions, gasoline blends, etc. all can create barriers to entry and raise the costs for firms in the market already. This can induce firms to shut down existing refineries and keep competitors out. Of course, the upside is that we get cleaner air.

As for the nuclear energy that Macroblog mentions I’m not sure I follow that one. I mean sure, I think it is a good idea in general, but in regards to gasoline and oil it isn’t going to do all that much since nuclear is for making electricity while oil and gasoline are for things like cars, trucks, and so forth. I suppose there is some issue of substitution, but in the short run it is likely to be minimal.

FILED UNDER: Economics and Business, General, ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Rick DeMent says:

    Environmental laws on emissions, gasoline blends, etc. all can create barriers to entry and raise the costs for firms in the market already. This can induce firms to shut down existing refineries and keep competitors out. Of course, the upside is that we get cleaner air.

    There are two things wrong with this; the first is that environmental laws somehow make the process of refining gas prohibitively expensive. Refining costs of gas when it was under two bucks a gallon were about 13% of the total price; now that oil is higher that % is less still. If we could wave a magic wand over the crude oil and produce the final product with no cost at all the price of gas would only go down about 30 cents. What % of that 30 cents is due directly to “environmental regulation” is an open question but I would venture a guess that what we are talking about amounts to pennies on the dollar. So rather then insisting that environmental laws are to blame here why don’t you actually find out if this is really true, my guess is that you would have a lot of difficulty finding a report from anyone other then the oil industry that claims “environmental regulation” as the cause for reduced refinery capacity.

    Your instincts about supply and profit seem more likely.

    Second you seem to think that the clean air is a sacrifice that has no downside. The fact is that air pollution plays a role in a whole range of respiratory illnesses there were almost unheard of 50 years ago on the scale we are seeing them now. So if all you want to do is transfer gas expenditures to health care expenditures then gutting the clean air requirements are a good way to get started.

  2. Herb says:

    I think you have some very good points in your commentary Steve. Congress has to take a big part of the blame for high gasoline prices. The environmentalist must also take their share and lastly, the oil companies are guilty as well.

    I think that I have pointed out in prior comments that “There is no oil shortage”. and there are plenty of reserves for the entire world. There is NO justification for oil to be at 60 plus dollars per barrel today.

    While I think we should do what we can for the environment, the environmentalists want everything their way or take to the highway. In other words, their attitude stinks and is hurting this country economically. The problem is, They just don’t care about anyone but their selfish selves.

    The oil companies don’t care either with their record profits rolling in by the boat load. They have stiffled competition and they should pay for it. The only for the immediate future is to have congress put an extrs “gross profits” tax on them until they see fit to aid other companies to get into the business.

    For Congress, we need to make it unlawful for oil companies and those associated with oil companies, to make any type of “political contributions” to any politicam.

    The high gasoline and home heating prices are going to put this entire country into an economic depression if something isn’t done FAST

  3. Steven Plunk says:

    Mr.DeMent comments concerning refining expense are correct except that the main point is the barriers to entry into the market for new refiners more than additional costs for existing refiners. Sure, refining is only a portion of the cost of gasoline once a refinery is built but the environmental hurdles to build a new refinery are huge in terms of time. Time is money.

    From consumers to OPEC there are no innocent parties to the mess we are in. Each must take the steps necessary to stabilize a market that all agree is out of control.

    Don’t forget the traders and the role they play in this through speculative buying. Once a few of these people are burned we may see return to rational prices.

  4. Herb says:

    Mr. Plunk:

    Speculators, I call them what they are “”Riverboat Gamblers” I hope their day comes sooner rather than later.

    Who, knows, Maybe we will all get lucky and see them jumping out of skyscrapers after they lose their shirts.

  5. Steve Verdon says:

    There are two things wrong with this; the first is that environmental laws somehow make the process of refining gas prohibitively expensive.

    I see no reason to continue reading your post when you start of with a strawman argument like this Rick.

  6. ken says:

    There has never been a refinery not built due to environmental laws. To argue otherwise is pure stupidity.

    When gasoline was under a dollar a gallon, not too long ago, companies were planning to shut down refineries due to excess capacity. Right now, with gasoline prices high, it is convienent for stupid people to blame it on government regulations. Bull!! High oil prices are what is driving up the cost of gasoline, not lack of refined product.

    Oil prices are higher due to worldwide demand for oil. You can build all the refineries you want but we are still going to pay more for gasoline in the future because the raw product will be costing more.

  7. Steve Verdon says:

    There has never been a refinery not built due to environmental laws. To argue otherwise is pure stupidity.

    Really, when was the last time a refinery was built in the U.S.?

    When gasoline was under a dollar a gallon, not too long ago, companies were planning to shut down refineries due to excess capacity.

    Evidence? No? Didn’t think so.

    Right now, with gasoline prices high, it is convienent for stupid people to blame it on government regulations. Bull!! High oil prices are what is driving up the cost of gasoline, not lack of refined product.

    Bwahahahahaha.

    Oil prices are higher due to worldwide demand for oil. You can build all the refineries you want but we are still going to pay more for gasoline in the future because the raw product will be costing more.

    A quick glimpse into the fevered mind of an unthinking liberal.

  8. Herb says:

    And now we have heard from Ken,
    His wacko ideas are so thin,
    He has been lied to like you
    By his comrades in blue’
    That the wackos have committed no sin.

    Ken:

    Show me where there is more demand for oil that there is supply.
    I presented my documentation of an excess of oil for sale, now you show me your documentation that there is a shortage.

    You are right though, “There has never been a refinery built due to environmental laws”

    But the environmental laws have hindered and onstructed the building of refinerys by increasing the cost of building as well as the fact that it takes 15 years to build one due to the EV wacko laws.

    Get Smart Ken, If possible

  9. ken says:

    Steve, Herb,

    You are two of a kind. Please explain how a lack of refining capacity, if one exists at all, drives up the price of a barrel of Saudi crude.

  10. KevinM says:

    Although we have a strategic petroleum reserve, this is for crude only.

    At this point, we have encountered not a market failure, but a market shortcoming.

    I think we should look into an intervention into this market shortcoming – the creation of a public good. And, alas, I can think of no one to do it other than the feds. Regulate it onto the oil industry and they’ll pass the costs right through to you know who.

    We have a reserve of refinery input, but we have a suboptimal reserve of refinery output (from a public policy perspective, not from that of the market suppliers).

    So let’s make one – or several actually. Gasoline, Diesel, Jet Fuel, AvGas, Processed Natural Gas, and Distilled Liquids (butane, propane, etc.). It’s not profitable for the various supply chains to keep 3 or 6 or 9 months supply on hand and distributed regionally. But the government could do that.

    If we had a system like that in place, I’m thinking we would be closer to $2 than $3 for gasoline.

  11. Herb says:

    Ken:

    I don’t know how you can say that I said that refining capacity was a factor in the price of crude. I have NEVER said that.

    In fact I have said quite the opposite. I have said that there is a surplus of crude available on the market and that “There is no justification” for the crude price to be high. In fact, I have said that the increases in crude price prior to Katrina should be decreased to the price long before Katrina hit.( say about 10 to 12 months ago.)

    Read my comments more carefully from now on Ken and try your best not to put your liberal slant on my comments.

  12. Rick DeMent says:

    Mr. Vardon,

    If your objection to my comment was the use phrase “prohibitively expensive” I admint it was a poor choice of words and I retract it and change it to “creates and significant barrier to refinery construction”. NIMBYisum is not environmentalism although NIMBYs often use that as a justification and no one seems to question the motives. I think that the burden of proof of that statement rests with Mr. Vardon.

    The substance of the comment, your pedantic objections notwithstanding, is that the environmental argument is suspect on its face.

    The biggest hurdle to the construction of refineries is lack of government subsidies due to the fact that the construction of more refineries would baring the price of gas down and cut into profits as you mentioned.

    I would challenge Mr. Vardon to use his oft touted power of economic reasoning to explain why on earth oil companies would spend the huge amount of money on more refineries when doing so would only lower the profit, that would not be the action of a rational economic actor.

    I’m kind of sad that Mr. Vardon would not address my point when I went ahead and addressed his unproven,and logically suspect assertion even though it doesn’t warrent a comment.

  13. Steve Verdon says:

    Ken,

    You are two of a kind. Please explain how a lack of refining capacity, if one exists at all, drives up the price of a barrel of Saudi crude.

    It doesn’t.

    Rick,

    If your objection to my comment was the use phrase “prohibitively expensive” I admint it was a poor choice of words and I retract it and change it to “creates and significant barrier to refinery construction”. NIMBYisum is not environmentalism although NIMBYs often use that as a justification and no one seems to question the motives. I think that the burden of proof of that statement rests with Mr. Vardon.

    Well thank goodness it rests with Mr. Vardon, whomever he may be.

    The substance of the comment, your pedantic objections notwithstanding, is that the environmental argument is suspect on its face.

    The biggest hurdle to the construction of refineries is lack of government subsidies due to the fact that the construction of more refineries would baring the price of gas down and cut into profits as you mentioned.

    This is nonsense as it is how all markets work. When there are economic profits in a market competitors enter and drive economic profits down to zero. This is not happening in part because of environmental laws. NIMBYism is another factor, but it isn’t the only factor. Only somebody who has a tenuous grasp of economics would suggest subsidizing an industry that is earning substantial profits.

    The U.S. used to subsidize refineries, older less efficient refineries that is. Of course, now without the refineries and the environmental laws such refineries are shutting down (a quick visit to the California Energy Commission puts the lie to Ken’s claim).

    Refining firms have actually used environmental laws to shut down competing firms. This reduces competition and increases the market power of the remaining firms. Increased market power is not usually associated with lower prices.

    I’m kind of sad that Mr. Vardon would not address my point when I went ahead and addressed his unproven,and logically suspect assertion even though it doesn’t warrent a comment.

    Poor Mr. Vardon, whomever he maybe.

    As for the rest of your argument,

    Refining costs of gas when it was under two bucks a gallon were about 13% of the total price; now that oil is higher that % is less still.

    Irrelevant.

    If we could wave a magic wand over the crude oil and produce the final product with no cost at all the price of gas would only go down about 30 cents.

    Glad to see you are in agreement with me. Refining gasoline is one of the factors in the price.

    What % of that 30 cents is due directly to environmental regulation is an open question but I would venture a guess that what we are talking about amounts to pennies on the dollar.

    With the gasoline consumption of the U.S. you are talking lots of dollars. So, this sort of proves my point, doesn’t it.

    So rather then insisting that environmental laws are to blame here why dont you actually find out if this is really true, my guess is that you would have a lot of difficulty finding a report from anyone other then the oil industry that claims environmental regulation as the cause for reduced refinery capacity.

    Clicky. Spend the $5 and get the whole thing.

    Now, check me on this Mr. DeMent, isn’t the prupose of environmental regulations and laws to internalize the environmental costs of various economic activities? If the answer is yes, then isn’t it fair to say that costs increase? If the answer is yes, then isn’t it also reasonable to conclude that the marginal firm might very well shut down? How many oil refineries were there in 1980ish? IIRC over 350. How many are left today? Well under 200.

    Consider yourself pwn3d.

  14. Herb says:

    Steve:

    I didn’t know you made a name change. LOL ?

    Tell me Steve, Just why are these environmentalst so unwilling to take responsibility for the results of their positions that have been made into laws that are having such a negative effect on the economy, and will certainly hurt a lot of average Americans this winter?