Americans have an addiction to cheap oil and it was engendered and nurtured by OPEC. This addiction could have gone on for many more years, except that OPEC, emboldened by the prospects of the global economic expansion and with the cover of the war in Iraq, got greedy and allowed oil prices to skyrocket way beyond oil's demand-supply equilibrium price.
Since much of the oil consumed in the developing world is government subsidized, the end users in those countries do not pay a market driven price, but an artificially low price. Thus, the fastest growing parts of the world felt no pain from OPEC's price hikes. This has led to huge increases in energy demand in China and India and helped drive worldwide oil prices higher than almost anyone could have imagined just a few years ago. Having said this, we think OPEC forgot all about monopoly pricing theory, and in the process, unleashed a backlash among American consumers, who bristled with each new all-time high price for a gallon of gasoline.
The laws of supply and demand and price elasticity have not been suspended for the oil market. Period.
Every student who takes a course in economics knows that monopolies or near monopolies like OPEC must always be careful to price their goods on the demand curve; in this case,meaning pricing oil where consumers will pay the going price and keep consuming more. It’s no different than a drug cartel. Price the drug right, hook the users and keep them hooked on cheap drugs, then let price gradually rise to meet the gradually rising demand. Then do it all over again, being ever careful not to raise prices so much that the hikes reach the users’ consciousness and provoke a “push back” that results in their cutting back consumption. The reason is simple. The drug-pusher knows if you raise prices so much that it moves to the front of the users’ minds, his clientele may decide to go into rehab and get off the drugs.
OPEC May Have Misjudged Us
The shocking rise in oil prices has, however, led to an unexpected outcome in the United States, which is still the most important oil market in the world. As gasoline prices moved past $4.00 per gallon, Americans began to cut back their oil consumption, something that many believed would never happen. In early July, US oil consumption is down 3% year-over-year, on top of 2% and 1% cut backs in June and May, respectively. Three data points make a trend, and Saudi Arabia and the rest of OPEC know the routine. They must stop the upward spiral of oil prices at all costs and soon; indeed, they must get oil prices down so most Americans think the whole thing was just an aberration. Again, as we have said in previous blogs, the reason is simple: conservation, substitution, and innovation.
Conservation, Substitution, and Innovation
Americans may have been addicted to cheap oil for a long time; however, if oil is not going to be cheap anymore, then American consumers are going to make some changes. They are going to conserve, even if it is only at the margin. They are going to use alternate forms of energy and transportation to make their daily rounds; and they are going to encourage and buy new technologies that will allow them to live the kind of lives to which they have grown accustomed.
Sales of high mileage automobiles are skyrocketing, while the sales of trucks and gas-guzzling SUVs have all but stopped.
The use of mass transit is growing rapidly.
High-efficiency heating and air conditioning equipment is flying off the warehouse floors.
GE says it is having difficulty keeping its high efficiency “energy smart” light bulbs on the shelves.
Because it is now cheaper to ship merchandise across the country on trains than on trucks, railroad stock prices are at 100-year highs, while trucking profits are poor.
Shopping center associations tell us retail sales remain close to last year’s levels, but the numbers of visits shoppers are making to the malls are down.
Wind farms have popped up in 20 states, including our own Indiana.
Capital is being invested in more fuel-efficient automobiles, homes, and offices.
Rapid Transit is sprouting up in many cities, Phoenix being the most recent. If you ask a Portlander from Oregon what they are most proud of about their city, you are likely to hear about the bike friendly byways, the beauty of the Willamette River, or the majesty of Mt. Hood, but soon you will hear about Max, the city’s rapid transit system. It’s clean, it goes where you want to go, and it’s cheap.
Why should we be surprised with these manifestations of conservation, substitution, and innovation? We have grown addicted to cheap oil, but that does not mean that it has addled our brains completely. Once before when OPEC put the squeeze on us, we cut back and overall consumption went sideways for many years.
In 1978 the US consumed 19 billion barrels of oil per day, at the time of the Iran-Iraq War. As prices rose rapidly and calls for conservation became more common, US consumption fell to about 15 billion barrels per day by 1983. It was not until 1994 that our total consumption and imports reached the 1978 levels.
According to “The Economist” a virtual explosion of alternative energy plans is underway throughout this country and the world. Wind power, solar power, clean-burning coal, liquid coal, nuclear power, geothermal, tides, grain based, hydroelectric, electric cars, hybrid cars – you name it somebody with very deep pockets is investing heavily in it and putting the brain power behind it to make it commercially viable.
The American consumer, which is the golden goose of the oil cartel, is squawking and we think it's likely to continue. A limit seems to have been reached by many Americans: rich or poor, they seem to have decided that this mass export of our dollars to the sands of The Middle East has gone on too long with too little to show for it. We are changing our consumption and driving habits; we are challenging each other to use less energy.
We remember 9/11 and where most of those terrorists called home, and we know that in some way we have been dancing too long at the end of somebody else’s string.
The geese have finally begun to realize they are being fleeced. It ought to be interesting to see how OPEC backs out of this one.
