Friedman Libertarian

I love family spam; you know, that forward of a forward of an email that’s been going around the Internet since the Morris Worm? Today’s forwarder just takes the skeleton of a post, adds some skin here and there so you see what they want you to see, and then adds the “Send to 30 people in 30 minutes or you won’t get lucky” tag at the bottom and there you go.

Well, I got one from someone in my family, that got past my Spamassassin, and though normally I’d let these go past and delete them, but I really wanted to make sure people in my family were more educated to the issue, and so I wrote this.

The forward:

Dropping Gas Prices

THIS IS NOT THE ‘DON’T BUY’ GAS FOR ONE DAY, BUT IT WILL SHOW YOU HOW WE CAN GET GAS BACK DOWN TO $1.30 PER GALLON.

This was sent by a retired Coca Cola executive. It came from one of his engineer buddies who retired from Halliburton. If you are tired of the gas prices going up AND they will continue to rise this summer, take time to read this please.

Phillip Hollsworth offered this good idea.

This makes MUCH MORE SENSE than the “don’t buy gas on a certain day” campaign that was going around last April or May!

It’s worth your consideration. Join the resistance!!!!

I hear we are going to hit close to $ 4.00 a gallon by next summer, and it might go higher!! Want gasoline prices to come down?

We need to take some intelligent, united action. The oil companies just laughed at that because they knew we wouldn’t continue to “hurt” ourselves by refusing to buy gas.

It was more of an inconvenience to us than it was a problem for them.

BUT, whoever thought of this idea has come up with a plan that can really work. Please read on and join with us!

By now you’re probably thinking gasoline priced at about $2.00 is super cheap. Me too! It is currently $3.19 for regular unleaded in my town.

Now that the oil companies and the OPEC nations have conditioned us to think that the cost of a gallon of gas is CHEAP at $1.50 - $1.75, we need to take aggressive action to teach them that BUYERS control the marketplace..not sellers.

With the price of gasoline going up more each day, we consumers need to take action.

The only way we are going to see the price of gas come down is if we hit someone in the pocketbook by not purchasing their gas! And, we can do that WITHOUT hurting ourselves.

How? Since we all rely on our cars, we can’t just stop buying gas.

But we CAN have an impact on gas prices if we all act together to force a price war.

Here’s the idea: For the rest of this year, DON’T purchase ANY gasoline from the two biggest companies (which now are one), EXXON and MOBIL.

If they are not selling any gas, they will be inclined to reduce their prices.
If they reduce their prices, the other companies will have to follow suit.

But to have an impact, we need to reach literally millions of Exxon and Mobil gas buyers. It’s really simple to do! Now, don’t wimp out on me at this point…keep reading and I’ll explain how simple it is to reach millions of people!!

I am sending this note to 30 people. If each of us send it to at least ten more (30 x 10 = 300) … and those 300 send it to at least ten more (300 x10 = 3,000)…and so on, by the time the message reaches the sixth group of people, we will have reached over THREE MILLION consumers.

If those three million get excited and pass this on to ten friends each, then 30 million people will have been contacted!

If it goes one level further, you guessed it….. THREE HUNDRED MILLION PEOPLE!!!

Again, all you have to do is send this to 10 people. That’s all!

Ok, the email dates itself (probably written in Dec/Jan of 2005), has delusions of grandeur, but totally misses out any coherent economic thought. When a family member sends something like this on in sheer ignorance of the actual underlying premise of the oil industry, I’m going to have to step in and inform everyone else as to the plight of the oil-dollar complex.

First, Unleaded Gasoline and Oil are commodity products. Their price is set not by the oil companies, but by the market, just like Gold, Wheat, Corn, Pork Bellies, etc.

• NY Mercantile Exchange has the futures contracts for Oil:
  http://www.nymex.com/lsco_fut_cso.aspx
• Same with Unleaded Gasoline:
  http://www.nymex.com/QU_cso.aspx

So, while the oil companies have some price flexibility, the free marketsets the price of oil and its distillates (gasoline, natural gas, heating oil, etc).

The second point is a bit of a tutorial in economics. You’ve heard it discussed, the “Supply / Demand curve”.

Wikipedia has a very coherent article on Demand that bears reading, but if it’s too long, let me summarize by pasting the 3rd paragraph from the article:

The laws of supply and demand state that the equilibrium market price and quantity of a commodity is at the intersection of consumer demand and producer supply. Quantity supplied equals quantity demanded is said to be at equilibrium. Equilibrium implies that price and quantity
will remain there if it begins there. If the price for a good is below equilibrium, consumers demand more of the good than producers are prepared to supply. This defines a shortage of the good. A shortage results in the price being bid up. Producers will increase the price until it reaches
equilibrium. If the price for a good is above equilibrium, there is a surplus of the good. Producers are motivated to eliminate the surplus by lowering the price. The price falls until it reaches equilibrium.

In an egocentric US view of the world, we indeed are the largest consumers of oil and gasoline, however, we are not the only consumer of oil. The US consumes 25% of the world’s oil, and also has the world’s largest economy, approximately 27% of the world’s economy is produced in the United States. Even if we reduced our oil importation to 0, we’d still be the third largest oil producers in the world, and the world would still consume 71 million barrels per day.

As demand for a good increases, the demand curve moves to a higher price equilibrium point on the supply curve. This means that the way to lower the price is to increase supply or decrease demand. OPEC has little to no further capacity to increase supply; for the most part, they’re pumping out as much oil as they can to sell to ExxonMobile / Royal Dutch Shell /
ConocoPhilips / etc to take massive advantage of the equilibrium price.

• The CIA’s World Factbook Stat on Oil Consumption:
  https://www.cia.gov/library/publications/the-world-factbook/rankorder/2174rank.html
• List of Countries by GDP:
  http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

China is now the 2nd largest consumer of Oil, and India is the 6th largest, with the 4th largest and 12th largest economies. The US’s actual oil consumption has declined over the last 18 months, primarily due to the price of oil. But overall worldwide demand for oil has increased. This became more pronounced in 1994, when China started consuming more oil than they were producing. India has always been an oil importer. And as the population increases worldwide, one can make a point that oil production will rise with population as well.

Third, is the profit motive and margin of an oil company. No business is in business to break even or to lose money. ExxonMobile (as well as Conoco / Shell / etc) are indeed involved at all points of the production of oil and gasoline (I think the term for this is Fully Integraded Vertical Oil Company). The wholesale price of a gallon of unleaded gasoline nets them a profit. There’s a profit built into the operation of the well. Sometimes the oil company owns the well, sometimes they don’t. Sometimes they own the means of transport, sometimes (Alaskan Oil Pipeline) they don’t.

Now, we’ve just got the oil out of the ground and in a tanker, for delivery. We now need to refine this oil. Did you know that there hasn’t been a new refinery built in the United States in 31 years. Refinery capacity has increased over that time, but did you ever wonder why gas prices spike just before summer and just before winter? Some states, California included in that, have different gasoline formulations for Winter and Summer. Preparing to refine for these times requires some downtime at a refinery to re-tool and change chemicals. During this time, the actual refining capacity of the United States drops. Because supply drops (Moves to the left), the equilibrium price increases and we have to import gasoline. Some claim that the oil companies have cornered the market to increase profit, others state that it’s the EPA, regardless, the US imports a third of the gasoline it requires. Because it’s cheap and easy to build refineries in foreign countries, both French and Indian companies are exporting large mounts of refined gasoline to the US, which reduces the amount of jobs that could be worked by US refinery workers if the refineries existed in the US.

The price you pay at the pump also has profit margins built in, but when the supply and demand curve state that the equilibrium point for wholesale unleaded gasoline is $2.55 (at the moment of this writing), this nets a profit for them before even getting it to the pump. According to Reuters, ExxonMobile’s profit margin is 10.94% over the past 5 years. This means that for every dollar they make, almost 11% of it is profit. Compare this to other oil companies: Chevron:
7.94%, Shell: 7.76%, Conoco: 8.05%. Pretty high? Now, compare this to other companies in the Dow 30: Walmart: 3.91%, Microsoft: 28.76%, JPMorgan:
17.09%, 3M: 13.84%, Merck: 13.54%, Coca Cola: 16.56%, Proctor & Gamble:
15.16%. The average profit margin of a Dow30 company is 12.15%. That means that $1.25 20oz bottle of Coke, 20% of it is profit for the Coca Cola Company. The $100 Vista operating system from Microsoft provide $28 in profit for Microsoft.

Once it gets to the pump, it’s quite a strange product to sell. For example, if you, as a gas station owner, act as an independent, that is, you’ll buy gasoline from the cheapest suppliers, those suppliers will email you prices every day and you pick one and they deliver. You won’t get any price quotes from a major oil company though. Their oil is only for their station. As a company station, the company sells you gasoline, tells you what you’ll pay for it, and tells you what you’ll charge for it. And what you charge for it is also a strange situation. For example, if you’re the last station before you hit a long stretch of highway (which also makes you the first station coming in the other direction), your price will be higher than a station with a lot of competition. Also, if the company says that discount station X is .2 miles out of your competition radius, your price will probably be higher than discount station X.

Why would a gas station become a company store? Credit Cards. First, company credit cards (Who remembers their Exxon credit card?) allow for customer stickiness; a customer who has the company credit card will tend to shop at that company’s stores. Also, the oil company will pay
for all your credit transactions. Typically Visa and Mastercard charge up to a 3% service fee to clear a transatcion (remember when Exxon used to charge different prices for cash versus credit?). At $3 a gallon, that’s now growing to 9 cents a gallon, quickly eating up the station owners profit. So if you want to help out your local independent gas station, pay cash.

Fourth, is speculation in the futures market. In 2000, Congress passed and Bill Clinton signed an act allowing this speculation. Prior to this law, only real end-buyers of the commodity could buy and producers could sell the futures. That means that you could only buy or sell the products (gas/oil/wheat/corn/soybeans) if you intended to consume or you produced the product. After the law went into effect, you could buy and sell contracts just like a stock. (Options / Short positions). Plus, all transparency ended. This enabled the sovereign countries (say Saudi Arabia) to bid up the price of oil themselves. Capital!

Looking at the average price of gasoline in the 21st century, the price of gasoline at the pump in December 2000 was $1.44. The price of a gallon of gas in December of 2003 was $1.47. Since then the price of gas at the pump has marched a steady path “up and to the right.”

This is partly to do with this speculation in the market. Hurricane Katrina was a watershed (pun definitely not intended) event that has now put extreme speculation into the oil market. Every time there is a hurricane or tropical storm that may threaten the oil platforms in the Gulf of Mexico, or the refineries in costal Texas or Louisana, the price of oil spikes. Every time Mahmoud Ahmadinejad opens his mouth and says something regarding the destruction of Israel, the price of oil rises. Any time Hugo Chavez threatens idiocy upon his oil supply, price increases.

The US imports 59.9% of its oil from abroad. Some of it comes from our American neighbors Canada & Mexico, but most is imported from OPEC.

And really, OPEC doesn’t want $100 oil. Yes, that does sound counter-intuitive, but follow me here. At $100 oil, or $3 gas, people start grumbling (hence your forwarded email) about alternative solutions. Well, people grumble all the time, but at $100 / $3, it starts actually becoming financially feasable to persue alternatives. In the Seattle area, B99 (99% Biodiesel) costs @4.119 per gallon, while petroleum diesel is priced around $3.90. Any development of a real alternative, something that will actually reduce demand is what OPEC is really afraid of. Yes, they do want to charge the highest price they can (propping up religious theocracies and populist despots costs lots of money to maintain), but they do realize that should the demand curve move left, their ability to remain in power diminishes. If companies actually put something out there that was truly an alternative fuel, that could be used without any engine replacement, and would cost $3 a gallon, you’d see the supply of oil rise dramatically to cause the price of gasoline to drop to where people will not pay $3 if they can get gasoline much cheaper.

Fifth, the performance of the US dollar hurts more than the demand curve. The US dollar index (DXY) is an unweighted average of of 6 currencies against the Dollar. Since August 1st, 1999, the Dollar has lost 28% of its value, reaching an all time low today. What this means is that if the price of oil was $50 a barrel on August 1st, 1999, the change in the value of the US dollar would put that same barrel at $64, discarding inflation. If you indeed do include inflation, that $50 barrel of oil now costs $82. If you compare that barrel of oil in Euros, that $50 barrel of oil is 46.50 euros in 1999. Not factoring in inflation, that barrel costs 32 euros now. Add in inflation and that barrel of oil costs 38 Euros.

Now, the price of oil in August of 1999 wasn’t $50, it was more like $19. OPEC, in it’s continued excelence as a centrally planned extortion ring, had flooded the market with too much oil (Supply curve moved to the right.) This glut caused the price to drop. They caught back up by year end and oil never returned to those levels.

If you compare what we pay at the pump, and what other countries pay, the US pays near the bottom in price per gallon, because those countries price in a hefty tax to pay for their tremendous public transport system (Remember this point for later). In France, the heart of the European Union, the price of a litre of (95 octane) gas is €1.37 euros, which converted to gallons is €5.17 euro per gallon. Convert the Euros to dollars, and you get a whopping $8.02 per gallon. Wow, that’s expensive. Until you factor in the taxes, it looks bad. Realize that 70% of the price of a litre of gas in France is taxes, this puts you at $2.46 a gallon without taxes. Then add in the same (as above) 18.4 cents for Fed, and 18.4 cent state tax, and you’re looking at $2.82 per gallon comparably.

So to summarize point #5, if the UN set a fixed price of $50 a barrel in 1999, and every country in the world adhered to this price, when factored in US inflation and the drop in the dollar’s value, that $50 barrel would cost $82 today.

Sixth, and finally, let me bust this myth right here:

Here’s the idea: For the rest of this year, DON’T purchase ANY gasoline from the two biggest companies (which now are one), EXXON and MOBIL.

If they are not selling any gas, they will be inclined to reduce their prices.
If they reduce their prices, the other companies will have to follow suit.

No, this won’t work. Looks good on the outside, reduce the demand, the demand curve moves, the equilibrium point moves lower.

Lets work on this fallacy, that the ExxonMobile does in fact lower its prices. For example (to make the math easy to understand), the cost at the pump is $3 a gallon. Demand moves to the left, and the resulting equilibrium point is $2.50 a gallon.

At that price, ExxonMobile is selling gasoiline for less than the going rate, as the boycott has only targeted them. Sweet, the people say, and start buying all their gasoline from ExxonMobile. Drat! all the other gasoline companies say, and lower their prices to $2.50 to compete.

Hurray! say the people as they are victorious!

Hah! says the economist. You forgot, people, that you did not stop consuming gasoline, just shifted demand. This demand moved to other companies, like Sunoco, Shell, Chevron, BP, Lukoil, Racetrack, Total, Citgo, etc. What happens when demand increases? These companies, unable to supply the new demand, increase prices. The People, resolute in defeating evil ExxonMobile, pay the increased prices because Exxon is Bad and Must Be Defeated ™. Exxon, lowers its prices. Sunoco, Shell, Chevron, BP et. al. realize that they can now buy gasoline from Exxon, becuase they now have a large supply with little demand. These companies buy from Exxon at a discount, and sell to The People at a higher price than before. The People, now with empty pocket books
because they’re paying $3.25 a gallon, start eying the $2.75 gas at Exxon, and break ranks, and start buying at Exxon. The other companies start lowering their prices to get the customer back, and Exxon raises their rates, and golly, we’re back at $3 a gallon.

What if it actually worked, and Exxon dropped their prices lower than what it cost them to produce, market, deliver and sell? As far as I know, Exxon employs 80,800 people. First thing they would do is lay off a good (10-20%) of these people to reduce their overhead. So, 8-16k
people would lose their jobs. Exxon would stop paying taxes, because they would be incurring a loss. Exxon paid 29.8 billion in income taxes in 2007. Please, read that last sentance again. That’s Billion with a B. How big is that? The US economy has 144 million workers. Somewhere
there’s a median, we’ll call him Jeff. If you were to line up all 144 million people in a line, Jeff would be smack in the middle. 71 million 999 thousand, 999 people would be behind him, 71,999,999 would be infront of him (sorta, you’d have to have an odd number but stay with me). Jeff makes $26,036 a year. Everyone in front of him makes more, everyone behind him makes less.

Now, the CEO of Exxon Mobile, Rex Tillerson (whom by the way makes 4.3million a year), walks up to the back of the line. He taps the last person in line on the shoulder, and has that person get in a line behind him. Rex walks up to the next to last peson in line (who is now the last person in line) and taps that person on the shoulder and has them get in line behind him. Rex does this for a while, until he gets to Jeff. He taps Jeff on the shoulder. Rex then tells Jeff that his company pays as much in taxes as every person in line behind him. Jeff is amazed, that’s a line of 72 million people. Rex then tells Jeff that the people in line behind Jeff pay 96% of all income taxes, which includes the taxes that Rex himself pays.

So, if Exxon made a loss, they’re able to deduct their taxes against that loss until they’re gone, just like any other business. That means for every dollar of loss from selling gasoline cheaper than it cost them, they’d pay a dollar less in taxes.

Why not pass laws to make them pay more, obviously they’re gouging the consumer? You do realize that corporations don’t pay taxes. Sure, they did just pay 29.8 billion to the government, but, heck, you know who really paid those taxes: the People. Any increase in the cost of doing
business, say a “windfall gains” tax, will get passed on directly to the consumer, so that their profit margin remains the same. So, in essence, by calling for more taxes you’re really just taxing yourself. And Exxon, as a global company that earns around 70% of their revenue from
overseas operations, could, and probably would, relocate their head office to a country with less onerous tax implications. Their tax rate in the US was 44%, i.e. for every dollar of net profit, they paid 44 cents in taxes. If they relocated to Ireland, they’d pay 12.5% in taxes, which would be very sound for a company to do. … Oh yea, that’s now 29.8 billion in taxes the US won’t be getting. Add in ConocoPhillips and Chevron and you’re looking at at least 50 billion in taxes that could leave the country and go pay someone elses government.

So, what can we do?

Could the US produce more of it’s own oil? Sure, but at every turn the congress has voted against it. And no one can be totally sure of the environmental impacts. There are large reserves in the Gulf of Mexico that the congress voted against drilling. There is also the Alaskan National Wildlife Refuge that could provide 1.4 million barrels per day. Also, a oil shale find in Colorado, Utah and Wyoming that houses at least 800 biliion barrels of recoverable oil (triple the reserves of Saudi Arabia).

Are alternative fuels helpful? Maybe, but not from Corn. Ethanol has a lower energy output when compared to Gasoline; that is, it takes more ethanol to return the same amount of energy involved when compared to gasoline. So if your car got 30 mpg on gasoline, converting it to pure ethanol would return 18.6 mpg. When you factor in the opportunity costs of using corn (Higher corn & feed prices, which then domino thru the economy resulting in higher costs for food), it doesn’t make sense to use corn for ethanol. But the agri-lobby is great on capital hill, so we use corn for ethanol. We (the tax payers) fund subsidies for Archer Daniels Midland to grow corn for ethanol. It would be better to use switchgrass, sugar beets, and sugar cane instead of corn.

Biodiesel? Mainly used with Soybeans, so you still end up with the domino effect with higher feed prices increasing the price of other foodstuffs. It still requires a mixture of diesel (typically 20% bio, 80% low sulfur), and freezes in the tank at a much higer temperature than normal diesel; pure biodiesel freezes at 25F.

What about telecommuting? There are supposedly 33 million people who could work from home. Based on this number, the US could reduce oil imports at least 24%. But not all jobs are able to telecommute, and there’s a mindset in vogue that you’re not doing “real” work unless you’re wokring in the office. AT&T required as many as 12000 telecommuters to start coming into the office after their November 2007 merger.

So, it’s easy. Reduce Demand, or Increase Supply. Supply side economics says drill for more. Demand side economics says drive your cars less. Supply side says develop new fuels, Demand side says increase public transportation. We’re already funding Ethanol to the tune of a 54 cents per gallon produced, and have a 51 cent per gallon tariff on imported Ethanol. Look what it’s done for beef prices.

But really, who is going to give up their car? I’d like to see someone who lives in Chesterfield County, oh say in Bon Air or so, take the bus into their job in downtown Richmond. It’s not going to happen. Or Powhatan into the city? Why not move closer? I’d love to see that happen; people moving in from Powhatan into downtown, at least it’s cheaper.

Same goes for the DC area, and here in the NYC area, where a 440 sq ft apartment goes for $1600 a month. Live close to a ferry here, and a 1br/1ba apr rents for $1200 a month. It’s quite easy and convenient to point to Europe for “Look at their Mass Transit systems, don’t they work well?” Sure they do, look at how dense their population is. France, which is typically compared to Texas (4/5th the size). Texas has 23 million people, France has 61 million. It’s much easier to pay for and move 61 million people in a country the size of Texas. The UK is then twice as population dense as France. (US: 31 people per square km, France: 110, UK: 246… Japan: 339.)

Look at the DC Metro, something I’m quite fond of. Even with 106 miles of track, servcing 702k people a day, DC has the second worst traffic in the US. Americans love their cars, even sitting in them 2 hours a day because you can’t afford to live any closer.

I don’t know what the solution is, but I can tell you what it isn’t: blind boycotts to “punish” an American company. I can also tell you what it isn’t, it’s not forwarding around chain emails to folks either. It’s somewhere in the middle of “stop driving” and “destroy the environment to pump every ounce of oil out of the ground.”

Perhaps some good first steps:

• Close what is called “The Enron Loophole” that allows speculation in commodities. This alone will drop the price of oil at least 20%.
• Fund the development of alternative fuels, made from non-essential non-foodstufs. Use something other than corn for ethanol production.
• Buy a more fuel efficient vehicle. And I’m not talking about a Hybrid. I think it’s stupid that the government gives a $1600 tax break if you buy a Hybrid. That Ford Escape hybrid gets 34 miles per gallon, but that Jetta Turbo Diesel (the same one my grandfather goes on about as one of his favourite cars of all time) gets 50+mpg. I think the tax break should be based on MPG not Hybrid or Not.
• Drive less. Seriously. That’s the one thing that will work. If everyone drove 50% less, demand will drop, the demand curve will move left, and the price of gasoline will drop. How do you do it? Thats up to you.