Peak Oil, Hotelling pricing and artificially low interest rates

[NCR85]

We all know that mainstream economists have a tendency to say that things like peak-oil can not happen, because the price system in it's infinite wisdom would never let major production level swings occur to the point of disrupting society substantially. The exact argument they make when you inquire further is pretty well laid out in the following two presentations:

Paul Krugman on the Hotelling price effect on commodities:
http://krugman.blogs.nytimes.com/201...-gold-wonkish/

Milton Friedman on the same:
http://www.youtube.com/watch?v=Jg7X-lZPaBM

Notice that the absolutely central variable in their argument is the interest rate. The interest rate is a vital link in the chain of interaction between the real world availability of resources and the market pricing mechanism.

What happens when the interest rate gets suppressed artificially? According to the Hotelling price theory, the resource's price rises and it's extraction rate is correspondingly stimulated to increase. Also, it's use for investment purposes has a less stringent requirement: the rate at which the investment's return "beats" the interest rate is lower.

I think the verdict here is clear: artificially suppressed interest rates create the peak oil boom-bust cycle. The mainstream economic argument against peak oil is nipped in the bud when the monetary system is corrupted, such as when a central bank promises to monetize the debts generated by the private sector once it's deflationary bust sets in. There is no contradiction between peak oil theory and genuine free market logic. The dissonance is entirely given rise to by the manipulation of the monetary system.

[don]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

artificially suppressed interest rates create the peak oil boom-bust cycle.

influence it - sure.

create it - no savvy.

[NCR85]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

The point is that without that "influence", the cycle is so smooth and non-disruptive that it just gets absorbed by the natural stabilizers of the market. Only interest rate suppression on a mass scale like we've seen in the last few decades (I'm certainly not implying this is a recent issue; the expectation that the Fed will at some point monetize the debts of the private banking system via the government account has been baked into the system for at least that long) can knock the whole system off it's feet like what will probably happen, and what 2008 was a precursor to.

[don]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

How does the increasing demand/increasing prices, falling demand/falling prices dynamic not result in a peak cheap oil plateau replete with bumps and bruises . . .

[NCR85]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

The price changes would get smoothed out by the arbitrage between future price and current price, thus causing consumption of the resource to get diminished, and investment in discovery and extraction to get stimulated, when the expected availability of the resource in the future is low. It would be a very smooth ride with hardly any "bumps and bruises". People would refuse to consume the resources because keeping them in the ground is more profitable due to the future scarcity.

Interest rates are at the center of the argument, though, and their manipulation throws a monkey wrench into the whole mechanism.

[don]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

People would refuse to consume the resources because keeping them in the ground is more profitable due to the future scarcity.

These are Happy Motoring Americanos you're talking about?



(no offense, pal. This expected epiphany is a moon shot . . .)

[NCR85]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

These are Happy Motoring Americanos you're talking about?



(no offense, pal. This expected epiphany is a moon shot . . .)

Can the straw men, dude. This isn't about "epiphany" or anything psychological. If you have a properly functioning market system with naturally adjusting interest rates, the elevated prices on the futures market for exhaustible resources make it a no brainer for the producers of oil to conserve the resource instead of extracting it. All the consumer notices is that there is less oil on the market so the price is higher on his end. For an indication of how those "Happy Motoring Americanos" limit even THEIR oil consumption, look at how vehicle miles driven in the US has been declining sharply as a proportion of GDP since the oil price rose to its current high plateau. Even well after GDP went back on a rising trend, driving continued it's decline:



http://www.businessinsider.com/vehic...driven-2012-12

Of course this is happening way too late to have enough of an impact to avert chaos, thanks to the borked up monetary system.

[don]

Re: Peak Oil, Hotelling pricing and artificially low interest rates

People would refuse to consume the resources because keeping them in the ground is more profitable due to the future scarcity.

the people you were referring to were

the producers of oil

my confusion, thought they were the sheeple . . .

[Polish_Silver]

interest rates and cycles

The price changes would get smoothed out by the arbitrage between future price and current price, thus causing consumption of the resource to get diminished, and investment in discovery and extraction to get stimulated, when the expected availability of the resource in the future is low. It would be a very smooth ride with hardly any "bumps and bruises". People would refuse to consume the resources because keeping them in the ground is more profitable due to the future scarcity.

Interest rates are at the center of the argument, though, and their manipulation throws a monkey wrench into the whole mechanism.

I'd agree that rate manipulation and financial leverage make these cycles worse. And not only in energy, but farmland, housing, just about everything. Hume noted that the boom bust cycle coincided with the invention of leveraged banking. (gotta find a reference for that!)


However, beyond rate cycles, there are middle east wars, oil spills, revolutions, droughts, all of which can cause fluctuations in supply and demand.

[don]

Re: interest rates and cycles

I'd agree that rate manipulation and financial leverage make these cycles worse. And not only in energy, but farmland, housing, just about everything. Hume noted that the boom bust cycle coincided with the invention of leveraged banking. (gotta find a reference for that!)


However, beyond rate cycles, there are middle east wars, oil spills, revolutions, droughts, all of which can cause fluctuations in supply and demand.

And, of course, people without jobs don't commute.

[Bundi]

Re: interest rates and cycles

And, of course, people without jobs don't commute.

I think we are supposed to call that enhanced efficiency.

[Bundi]

Re: interest rates and cycles

I'd agree that rate manipulation and financial leverage make these cycles worse. And not only in energy, but farmland, housing, just about everything. Hume noted that the boom bust cycle coincided with the invention of leveraged banking. (gotta find a reference for that!)


However, beyond rate cycles, there are middle east wars, oil spills, revolutions, droughts, all of which can cause fluctuations in supply and demand.

May want to toss peaking, plateauing, and depleting conventional sources into that litany of factors.

[don]

Re: interest rates and cycles

Ethanol Surplus May Lift Gas Prices

By MATTHEW L. WALD

WASHINGTON — A glut of ethanol in the gasoline supply is threatening to push up prices at the pump and may have exacerbated the growing cost gap between regular gasoline and premium, some oil experts say.

Refiners have been trading so-called ethanol credits furiously in an effort to meet federal environmental mandates, helping to significantly push up the cost of those credits — a jump to more than $1 from a few pennies in the last several days, and drivers are feeling the effects, experts say.

Prices for premium gas are now about 30.2 cents over the price of regular, according to Trilby Lundberg of the Lundberg Survey. That is up from 24.1 cents in 2010 and 18.2 cents in 2000. Any increases could affect about a third of this year’s car models, because premium fuel is required or recommended for them, according to Edmunds.com.

Experts disagree on the reasons for a widening gap between the costs of regular and premium gas. Reasons for the ethanol surplus are even more broadly in dispute, between producers and the oil companies. Gas companies are required under federal law to blend a certain number of gallons of ethanol into the fuel. But refiners argue that some cannot reach that requirement because they are nearing or at the so-called blend wall, the maximum percentage of ethanol in gasoline that most gas stations can handle, 10 percent. They also note that is the maximum level recommended by auto manufacturers for most cars.

Refiners blame Congress, arguing that the ethanol quota was set at a time when gasoline demand was expected to rise steadily. Instead, demand has declined, and refiners, obligated to blend more ethanol than they can actually use, have resorted to buying a lot of ethanol credits, known as renewable identification numbers (or RINs), to meet the mandated levels.

Ms. Lundberg described this as “buying forgiveness from the government.” The credits’ popularity has driven up the price nearly tenfold since January.

On the other side of the debate are the ethanol producers, who say prices are pushed lower because their product is cheaper than gasoline. This is true on a gallon-per-gallon basis, although ethanol provides less energy per gallon.

The argument over ethanol and gas prices highlights the politics of the Renewable Fuel Standard, set by a 2007 law. The ethanol lobby accuses the oil companies of ratcheting up the demand for fuel credits as a way of applying pressure on lawmakers to reduce the alternative fuel mandates. Congress could change the rules, or the Environmental Protection Agency, which set up the electronic marketplace where ethanol credits are traded, could adjust them.

The ethanol credits, like some other kinds of environmental credits, can be banked as well as bought and sold. Some companies have a surplus. But those without them have rushed into a market that is thinly traded, driving the spike in prices, according to the American Fuel and Petrochemical Manufacturers, a trade association.

“The market’s broken, because the Renewable Fuel Standard has been broken since the day it was enacted,” said Charles T. Drevna, president of the group. The refiners rely on a certain amount of ethanol as a way to increase octane, but they have been fighting the standard since it was created, partly because it requires them to use advanced biofuels that are not actually in commercial production.

Oil refiners also warn that higher prices for the credits will encourage fraud, something the ethanol trading system has encountered in the past.

There are two ways the ethanol credit issue could drive gas prices higher. Mr. Drevna said that refiners would probably seek to recover the cost of the credits, which were a mere seven cents or so at the beginning of this year, in the prices they charge. And Eric G. Lee, an analyst at Citi Research, said that some refiners might seek to avoid the ethanol requirement by exporting their gas, which could tighten supplies in the United States.

According to Mr. Lee, large refiners spent $100 million to $300 million each for credits in 2012, when prices were about 4 cents. “At $1 a gallon levels, the numbers become astronomical very quickly,” he said Wednesday.

But at the Renewable Fuels Association, Bob Dinneen, the president, said that the refiners were the sellers of the credits as well as the buyers, so that it was a flow of money among the oil companies. Ethanol companies make the fuel, he said, and sell it to refiners, who either use it themselves to meet their obligations, or use it but spin off the credit for sale to someone else.

“When I see volatility like that in any market, it’s not market fundamentals at work, it’s probably something else all together,” he said. “It’s more like the oil companies trying to create a little hysteria to support the notion that the Renewable Fuel Standard is broken, but I think it’s working just fine.”

He said oil companies should be investing in stations so that they can sell e85, the blend that is 85 percent ethanol and 15 percent gas, which millions of “flex fuel” cars can use, or e15, the 15 percent blend. The E.P.A. has approved e15 for most cars but the manufacturers advise against using it, and most service stations would need substantial investments in new equipment to sell it.

Using ethanol once was a cheap way to increase octane to make premium fuel, said an oil expert, Lawrence J. Goldstein, of the Energy Policy Research Foundation, because it has an octane of 113. But refiners have reached the limit of the amount they can blend, he said.

In addition, he said, an increase in American oil production, mostly from shale, allows refiners to use domestic crude instead of imported crude, but some of the new domestic supply has fewer high-octane ingredients than the African crudes it is replacing. And some refiners may increase their exports of gas in response to high credit prices, experts said. If the gasoline is exported, it does not have to meet the American ethanol requirement.

The long-term outlook for premium fuel is uncertain. Auto companies can build cars that get more miles per gallon if they use high-octane fuel, and the auto companies have agreed to double the average fuel economy of their cars and light trucks by 2025.

At Edmunds.com, analyst Bill Visnic said the demand for premium would be higher except that carmakers had learned to use an alternate technology, direct injection of fuel, combined with turbocharging, to get higher mileage.

But the number of cars that use high-octane fuel is substantial.

Michael Webber, of the Center for International Energy and Environmental Policy at the University of Texas at Austin, said he asked his students how many of them drove cars that needed premium fuel. “Out of 100 people, 10 hands went up,” he said.

These were probably not mostly luxury cars, he said. “Grad students normally aren’t rich,” he said.

[Polish_Silver]

Ethanol mess

The above article shows the futility of mandating the use of something not economic.

If ethanol was really economical, they would not need all these laws, penalty systems, etc.

[GRG55]

Re: Ethanol mess

The above article shows the futility of mandating the use of something not economic.

If ethanol was really economical, they would not need all these laws, penalty systems, etc.

"Saving the environment" (not to mention feeding the Agro Lobby in the USA) doesn't come cheap...