August 31, 2005

Coping with the gasoline shortfall

Today's announcements by the Department of Energy on the use of the Strategic Petroleum Reserve and by the Environmental Protection Agency on fuel standards are steps in the right direction. But we should be clear about the magnitude of the challenges ahead.

From the Washington Post:

The Bush administration will release oil from federal petroleum reserves to help refiners affected by Hurricane Katrina, Energy Secretary Samuel Bodman said Wednesday. The move, which was expected later in the day, is designed to give refineries a temporary supply of crude oil to take the place of interrupted shipments from tankers or offshore oil platforms affected by the storm.

This strikes me as exactly the right way to use the Strategic Petroleum Reserve. Hurricane Katrina disrupted both the importation of 1 million barrels of crude shipped to refiners through the Louisiana Offshore Oil Port and 1.4 million barrels per day of offshore crude oil production. Some refineries are already reporting that they've been forced to reduce operations as a result of a lack of crude. At least some of this disruption in crude oil supply is purely temporary-- Bloomberg reports that partial shipments through the port might begin as early as today. Using the SPR to bridge a temporary but potentially very serious production or delivery shortfall is exactly what the system can and should be used for.

On the other hand, it would be neither effective nor appropriate to try to use the SPR to deal with some of the longer term problems that Katrina has created. The Oil Drum carried this pessimistic summary:

There are MANY production platforms missing (as in not visible from the air). This means they have been totally lost. I am talking about 10's of platforms, not single digit numbers.... 90% of [the stand-alone caisson wells] in the storm path are bent over, rendering them a total loss, We would have to remove the existing bent structure and drill a new well, as bent pipe is basically unusable....We are looking at YEARS to return to the production levels we had prior to the storm.

In any case, more crude won't help the 8 refineries with 1.79 mbd capacity that have been shut down directly by the storm and its aftermath. But one measure that will help cope with that problem is today's announcement from the Environmental Protection Agency that it is exempting all 50 states from federal fuel volatility and sulfur standards through September 15. Those who have followed my discussion of these fuel standards will know that I see this as one bit of welcome news. In addition to allowing a greater quantity of usable gasoline to be produced, the EPA measure will create a more integrated national market in which it will be easier to get the fuel to those communities where it is most needed. I was worried that the interaction between the refinery outages and the patchwork of isolated retail markets would produce a logistical nightmare. I applaud the EPA for this kind of "outside the box" boldness in responding to the problems. For the first time in quite a while I have some confidence that our government is prepared to take some of the steps needed to deal with this crisis.

But then I look at the size of the challenges we face today. The price of the September gasoline futures contract went as high as $2.92 a gallon today before closing at$2.61. That $2.92 high would be$1 more than the price of the same contract last Friday. Contemplate the consequences if the retail price were to move $1 per gallon in a few days, and you grasp the magnitude of the situation we're in. Bloomberg found at least one person who has contemplated it: "We're going to be over$4 a gallon retail by the end of next week," said William Shireman, executive vice president of Gas City Ltd., a 50-station chain based in Frankfort, Illinois. Shireman said major oil companies have stopped selling unbranded gasoline to independent retailers in Illinois and have cut back on contract allotments. He declined to say which companies were halting unbranded sales. The wholesale price he pays for gasoline has "gone up about 80 cents a gallon in two days," he said.

Are you ready for that, America?

Posted by James Hamilton at August 31, 2005 03:51 PM

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I too applaud the EPA decision - as long as it remains temporary. The map illustrates a problem with the current system of different blends, but we have to remember why we have those requirements in the first place too. Anyone who traveled to LA before the Clean Air Act understands ... and San Diego (my home town) would be impacted today without the CAA.

Also - There was a rumor of gas rationing in Atlanta today that illustrates the need for honesty and transparency. People panicked and stations had long lines:

Despite Rumors, No Gas Shutdown Ordered
http://www.wtoctv.com/Global/story.asp?S=3789903&nav=0qq6dyvL

Hopefully we can avoid rationing.

Posted by: CalculatedRisk at August 31, 2005 05:05 PM

Unleaded regular was over $3 at the gas station nearest my house this afternoon. I heard on CNN that it was over$4 at some stations in Atlanta when this rumor hit of shortages. Unfortunately these rumors tend to be self fulfilling as everyone goes out and fills up, leaving less gas for everyone else.

In the 70s they instituted this strange form of gas rationing called odd/even. Basically if your license plate ended with an odd number you could only get gas on an odd-numbered day of the month, and if it was even you could only get gas on even days. It sounds corny but it actually helped with the lines.

Posted by: Hal at August 31, 2005 05:24 PM

I agree CR - the air of many major US cities would be as bad as Beijing or Mexico City if they leave them off for too long... America, are you ready for that as well? Besides dumping the regs won't have much effect on price... when the damage is this bad there are no quick easy fixes.

I can see the temporary exemption to allow shipment of already produced or soon to be produced product into areas of severe scarcity that wouldn't be allowed due to the regs... but those regs are there for a reason... and as a person trained as a chemical engineer and now working in the automotive supply chain... I understand why they were put there. We need to get back to a normalcy VERY quickly... even if at high prices.

Posted by: dryfly at August 31, 2005 07:50 PM

$4 won't hit me, personally too hard. Before I bought my present car I was already paying nearly$200 a month for gas with the old prices of about $2.60 a gallon. If I drive it right, I can get 38mpg with my new car and pay half that. And I plan to drive it very conservatively for the next few months. It's the inflationary pressure that this crisis will cause that worries me. Oddly, a friend of mine is actually looking forward to inflation. Posted by: JonBuck at August 31, 2005 07:54 PM I live in Phoenix. Last summer there was a pipeline break on the main line from Tucson to Phoenix. The problem was not so much that the pipeline broke but that the communication from those involved was horrendous. As a result people panicked. There were gas shortages that reminded me of the seventies in a matter of hours. Lines stretching for miles and people fighting at the pumps. What had happened was that everyone rushed out to get gasoline even if they didn't need it. They "topped-off" because they didn't want to get caught without gas come Thursday when they really needed it and no one at the pipeline company or the local government was saying anything. It happened so fast that prices never really adjusted up, they just ran out of gas. I had to wait in line for 40 minutes at 3:30 in the morning and barely made it to the pump before my Accord ran out of gas. It was actually a very sobering display of our outright addiction to oil, gas and the convenience of being able to get where we want, when we want. The thing that struck me though was that everyone I spoke with was not as concerned with price as they were with having the gas. Anecdotally, they would have paid$4, $5 or$6 to have the gas. Easy to say when you don't have to pay it, but in a city like Phoenix or LA, you need a car. On that, does anyone have any idea of localized elasticity of demand for gas? ie-Manhattan vs LA, etc...

Posted by: Sleith at August 31, 2005 09:08 PM

Us old farts remember very clearly when ones gas coupons got you two gallons a week if you did not have a very good story why you should get more. Three gallons for "essential" jobs. think about how one would cope with that.Ever see a freeway with everyone driving at 35? Sleep in your buddies garage and drive home for the weekend---sloowly. Meanwhile, since almost everyone thinks that their driving is essential and the other guy is cruising aimlessly,keep sucking up that gasoline. GO VALERO! I'd get mugged if you knew my cost basis.

Posted by: howard weston at August 31, 2005 10:01 PM

being a poor minority every nickel increase hurts me
when that hurt tricles down to the "middle class" than maybe economic justice will prevail

Posted by: kuros at September 1, 2005 08:17 AM

I don't think you will see a huge impact on air quality. Yes, it will decrease, but most likely on the order of a few percent. Modern cars are much, much cleaner than stuff from the seventies. Catalytic converters function during the first minute of a vehicle's operation in most cases. After the engine is warm the fuel-injection computer is looking at the oxygen sensor to keep the fuel/air ratio right. I have seen more than one car pass emission testing easily (less than 10% of allowable output) with the cat removed.

Ethanol as a fuel additive is, and always has been, a complete crock. It lowers emissions a tiny bit in a seventies-era V8, true. It also lowers fuel mileage...so everyone burns a little more, and there's exactly as much crap in the air as before. Net value: zero, except to ADM, which collects a subsidy for the ethanol.

Posted by: alex at September 1, 2005 09:32 AM

Kuros:

I am not certain what you define as economic justice but you seem to suggest that it is everyone being equally poor. Regardless of the price of gas, I predict that those who save and accumulate wealth will continue to save and accumulate wealth and will cut spending. Those who spend everything they get will continue to spend everything they get, and will not accumulate wealth. Bad things can happen, but the cost of gas is not what will make one poor.

Posted by: Bill Ellis at September 1, 2005 09:52 AM

I'm persuaded of the need for some gas regs, but I'm not the least bit persuaded that there are really 42 importantly different varieties of smog. Most of the ridiculous variations in the minutiae are simply the random product of grandstanding legislators. And let's not forget the not-so-hidden farm subsidies, i.e. "ethanol".

I also wonder whether we really need mid-grade gas, which adds yet another permutation.

On top of that we bear the burden of those who advocate capriciously discriminatory coercion in the 1970s style, tendentiously instructing everyone else on moral living even as they themselves expend staggering quantities of fuel on self-promotion, flying here, flying there, and flying everywhere to go on book tour or to physically go to "conferences" merely to personally drone through PowerPoints.

Posted by: PaulS at September 1, 2005 10:05 AM

There are really two issues here as far as the gas quality regulations. One is the crazy quilt of patchwork regulations. This adds costs for refiners and can contribute to localized shortages when there are supply problems. The other is the basic principle of regulating gas quality in order to reduce air pollution.

Clean air is a public good and by standard economic analysis it will be under-provided by free market activities. Each person would rather buy cheaper but dirtier gas because his personal contribution to air pollution is minute and the savings in gas price is far greater. But when everyone does this, everyone suffers from terrible air pollution, and each person would rather pay the few cents more per gallon and have cleaner air. But no individual can help; even if he did pay more for cleaner gas it won't make any difference in the big picture. It is a classic market failure.

I grew up in Los Angeles in the 1960s, and I remember how bad the smog would get in the summertime. We played hard, but each of us would have to stop periodically as our lungs would burn and our eyes would sting from the smog, waiting a few minutes until the pain went away and we went back to our wild games. In retrospect it is amazing that we were allowed to play in such toxic conditions - today they make all the kids go indoors and sit quietly, even when the smog is much less than what we experienced every day.

So there is a role for regulation in this picture. The problem is that it is hard to design mechanisms that lead to the optimal level of regulation. The current system doesn't work very well, as shown by the map JDH published the other day.

I don't know if it makes sense to have the same gasoline regulations for the whole country. Why should Montanans with their wide open spaces have to pay for a grade of gasoline designed to keep Los Angeles air clean? At some level it does make sense to formulate the gasoline appropriately for local conditions. But this process can clearly go too far.

Maybe we could have a national specification of a few different grades of gasoline, then let each state decide which grades would be used in which places. I'd think that half a dozen or so different variations would be enough. That might lead to a more manageable and less costly approach to reducing air pollution.

Posted by: Hal at September 1, 2005 11:33 AM

Alex - oxygenated fuels reduce milage by such a small amount you have to run contolled standardized tests to measure it... one of my BIL's actually works at the EPA labs running the tests... tiny statisitical difference. First there is only a small quantity of oxygenated components in the blend (10% max - usually quite a lot less outside the Midwest). Secondly the drop off in energy per volume (not weight - volume) is minor... Lastly other inefficiencies DWARF the differences in fuel energy and that noise buries any difference people like us observe - even though we swear by them.

Having said that and also having worked in fuel ethanol buisness - it is mostly a crock full of pork because it takes so much energy to produce fuel ethanol. It drives me crazy that we use gobbs of energy to plant fertilize and harvest food just to turn it back into fuel. If they are serious about 'ethanol' then they have to find a better feedstock than the precious gold of the Midwest... that should be reserved for hungry people... no shortage of them.

And lastly oxy fuel additives & ethanol particularily actually reduces air quality in many cities because it increase the volatility of the fuel and causes it to evaporate much easier... escaping into the air unburned from gas stations & automobile gas tanks... those vapors & sunlight cause a lot of the smog you see in large cities in hot sunny climates... ethanol makes it much worse.

The problem with the easing the regs & why it is so bad has NOTHING to do with the cars or the catalytic converters... it is the high sulfur content they are allowing... that is the problem... I don't car how clean your car runs or how well your cat conv performs... the sulfur passes right through and makes for a very nasty air mix... like sulfuric acid vapor.

Posted by: dryfly at September 1, 2005 12:59 PM

The two methods for coping with a supply shock such as we are experiencing with gas supply are 1)physical rationing at some "reasonable" price and 2) economic rationing by allowing prices to rise to the "market clearing" level.

The problems with either approach are well known. Physical rationing causes shortages, long gas lines and possibly violence. Economic rationing may may be inequitable in that people in the lower socio-economic classes are harder hit even though their contribution to the economy may be critical; think of the fireman or the rural doctor who may difficulty traveling to work with gas at $5 versus the media star who may not even notice the financial effect of gas at$10.

I think it's time to consider a third way which was used successfully during the California energy crisis. In recognition of the fact that everyone needed a basic amount of energy at a reasonable price while wanting to use a market mechanism, the utilities introduced pricing tiers based on one's consumption above a base level. So, for example, people consuming up to 100% of the base allocation paid say 11 cents/kWh, consumption of the next 20% above the base allocation was charged at say 15 cents/kWh up to consumption above 200% of base allocation being charged about 25 cents/kWh. It worked extemely well in that large users of electricity took notice when a portion of their bill was being charged at 25 cents/kWh and reduced their consumption. Of course, this solution was relatively simple to implement for electric energy because the industry was already regulated, the consumption was at a fixed location, etc. However, I am sure a similar program could be devised for gas.

Posted by: RayJ at September 1, 2005 01:24 PM

I hate the concept of tiered pricing because it makes judgments on how much gas someone "ought" to use.

But, I'm still going to tell you how to do it: give every car owner a certificate good for $10 off 10 gallons of gas. And every registered car owner gets one of these a week. I still chafe at the idea. I don't use 10 gallons of gas a -month-. Posted by: Dan at September 1, 2005 01:44 PM Tiered rationing - oboy - will the WWII ration stamps be good once again? If you issue ration stamps they will be traded like food stamps, and those who are the poorest won't have gas, and those that are the richest will. Keep the government and the printers out of the equation. Bill Posted by: Bill Ellis at September 1, 2005 01:56 PM Incidentally, there are gas stations in North Carolina that are closed because they are "out of gas." Looks like the equivalent of bank runs, except that a gas station recovers as soon as it gets fuel delivered again. Posted by: Dan at September 1, 2005 02:03 PM Bill and Dan, I understand your concerns about tiered pricing. The idea though is to "improve" on the other two mechanisms. By the way Bill, trading the "coupons" may not be such a bad thing; that is how some emissions trading schemes work. And it may even make Dan feel a bit better! The question though is: do you prefer physical rationing or economic rationing and why? Or maybe you have some other method that works better. I would be interested in hearing your thoughts. Posted by: RayJ at September 1, 2005 02:45 PM Check this out, from http://www.leadingthecharge.com/stories/news-0066418.html and other places from news.google.com: While on the plane, Bush took a call from King Abdullah of Saudi Arabia. "The king offered Saudi Arabia's support," said White House spokesman Scott McClellan. The world's biggest crude oil producer, Saudi Arabia has pledged to boost output by 1.5 million barrels a day -- to 11 million -- to replace shortfalls. What gives, House of Saud? I thought you guys were already pumping at maximum capacity? Posted by: Dan at September 1, 2005 02:59 PM Here's a URL for the "Charlotte runs out of oil" story: http://www.news14charlotte.com/content/local_news/?AC=&ArID=101499&SecID=2 "Minutes after local and state leaders asked people to conserve gasoline because of a temporary supply shortage, long lines formed at gas stations all across the region." "City leaders asked people not to panic, but it seems like that is exactly what is happening. Instead of conserving, people are filling up." Posted by: Dan at September 1, 2005 03:39 PM Alex wrote: "I don't think you will see a huge impact on air quality. Yes, it will decrease, but most likely on the order of a few percent. Modern cars are much, much cleaner than stuff from the seventies. Catalytic converters function during the first minute of a vehicle's operation in most cases. After the engine is warm the fuel-injection computer is looking at the oxygen sensor to keep the fuel/air ratio right." From wikipedia: "A catalytic converter in an automobile's exhaust system provides an environment for a chemical reaction where unburned hydrocarbons completely combust, using platinum and rhodium as catalysts. Hence the combustion (redox) process continues, but outside the engine's combustion chamber, so no useful energy is extracted. Toxic car gases such as unburned hydrocarbon (UHC) and carbon monoxide (CO) would not exist if the fuel to energy conversion in the engine were perfect. A three-way catalytic converter has three simultaneous tasks: oxidation of carbon monoxide to carbon dioxide: 2CO + O2 → 2CO2 reduction of nitrogen oxides to nitrogen: NOx → O2 + N2 oxidation of hydrocarbons (unburnt fuel) to carbon dioxide and water: CxHy + \left ( x+\frac{y}{4} \right )O2 → xCO2 + \frac{y}{2}H2O These three reactions are most balanced at the stoichiometric point, where there is a balanced amount of oxygen to fuel in the engine. When there is more oxygen than required, then the system is said to be running lean, and the system is in oxidizing conditions. The above two oxidizing reactions (oxidation of CO and hydrocarbons) are favoured. When there is more fuel than oxygen (stoichiometrically), then the engine is running rich. The reduction of NOx is favoured. Catalytic converters become ineffective in the presence of lead, and the introduction of catalytic converters triggered the end of leaded gasoline." Catalytic converters lower the CARBON MONOXIDE and NITROGEN OXIDES emissions. They are bad because they are both toxic. So, the catalytic converters really help to lower the toxic emissions form automobiles, however they NOT lower SULFUR OXIDES emissions. So, if the public use gasoline with HIGH sulfur concentration the catalytic converters will make NOTHING to lower the the sulfur oxides emissions. The smog have two chemical causes: nitric oxides and sulfur oxides. The consequence is clear: if the gasoline have more sulfur there are more smog. The catalytic converters will help to have less smog under normal conditions, but they lower only the nitric oxid emissions, not the sulfur oxid emission. But as the combustible will have more sulfur (and not more nitrogen) the net effect is that the catalytic converters effect to lower the air pollution that will result from combustible with more sulfur is NULL. Conclusion: you will see more smog at Los Angeles. The impact will be related to quantity of sulfur that the combustible have. If you use combustible with more sulfur you will have more smog. Catalytic converters will NOT lower that effect. João Carlos Sorry the bad english, my native language is portuguese. Posted by: João Carlos at September 2, 2005 05:48 AM Dan: Saudi Arabia typically has said that they have about 0.5 mbd of excess capacity. However it's very heavy sour crude which no one thought was worth buying. Additionally, Saudi Arabia could have their own stockpiles and this would be their equivalent of releasing the SPR. Another option could be that perhaps they can pump faster, but it has poor long term effects on the life of the well. This I think is less likely, than either spare heavy crude, or releasing reserves as production. But if Suadi Arabia actually has an additional 1.5-2 mbd of non-damaging production, this would be a great reason why no one shouldn't buy anything from any oil organization unless they release more specific production numbers. Daily, or at least weekly individual well production numbers. Posted by: coffee17 at September 2, 2005 06:02 AM RayJ If you utilize coupon rationing the$10 suggested coupon would ultimately be a payment from government coffers. In my experience, $1 sent to Washington becomes$.50 through the miracle of government efficiency. The immediate result of economic rationing is the same, the rich get gas and the poor don't. The long term product of government spending is higher taxation in some form. Higher taxation does more to keep the poor poor through unemployment than it does to penalize the rich.

Bill

Posted by: Bill Ellis at September 2, 2005 06:14 AM

Folks, thank you for the clarifications and corrections. I hadn't realized they were relaxing the sulfur standards (lazy me, what I get for not reading closely enough) and that is indeed not at all good for air quality.

Sigh. Hopefully the offline refineries can be restored to service withing weeks rather than months or years. Until then, we will just have to hope that high prices keep consumption down...

Posted by: alex at September 2, 2005 01:33 PM

What is the difference between "price gouging" and the free market finding the balance between supply and demand?

Posted by: brett at September 2, 2005 02:00 PM

Brett, count me among those crazy economists who believe that "price gouging" is in the best interests of society as the appropriate response to a crisis. I was thinking of writing about this, but noticed that several others already have, including:

http://blog.mises.org/blog/archives/004038.asp

http://www.williampolley.com/blog/archives/2005/09/index.html#000417

Posted by: JDH at September 2, 2005 02:24 PM

I can't believe it, my co-worker just bought a car for \$11135. Isn't that crazy!

Posted by: Betsy Markum at November 16, 2005 09:08 AM