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The Truth Behind High Gasoline Prices

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
March 6, 2012

IN THIS ISSUE:

1.  4Q GDP Came in Better Than Expected

2.  Bernanke Defends Quantitative Easing

3.  The Truth Behind High Gas Prices

4.  How US Could Become World’s Largest Energy Producer

Introduction

Being in the business I am, people frequently ask me why gasoline prices are so high. Of late, people have also been asking me if President Obama has any idea whatsoever about how the energy markets work. As it turns out, the Heritage Foundation just released an excellent report that addresses both questions. It also lists five specific actions that Congress and the Obama administration should undertake to increase energy production in this country.

But before we get to that, I will summarize the latest economic reports which continue to give mixed signals. While the latest report on 4Q GDP came in a bit better than expected, most economists agree that growth in 2012 will not be as good as the 4Q of last year. Following that, we look at some remarks from Fed Chairman Ben Bernanke in his recent Senate testimony.  While he defended quantitative easing, it doesn’t sound like the Fed is going to do QE3 anytime soon.

4Q GDP Came in Better Than Expected

Last Wednesday the Commerce Department released its second estimate of 4Q GDP. The number was a bit better than expected 3.0% (annual rate), up from 2.8% in the advance estimate. The report once again confirmed that the biggest driver by far in the economy in the 4Q was inventory rebuilding, typically a temporary phenomenon, followed by growth in consumer spending. It was the strongest growth in a year and a half.

Most economists agree that growth in 2012 will not be as good as the 4Q of last year. The consensus among the 50 economists surveyed by Blue Chip Economic Indicators (BCEI) is that the economy will grow by only 2.3% in 2012. Specifically, the consensus predicts growth of 2.1% in the 1Q, 2.2% in the 2Q, 2.4% in the 3Q and 2.6% in the 4Q. For 2013, the consensus predicts growth of only 2.6%.

Other groups individually think the BCEI consensus is too optimistic.  Wells Fargo economists expect GDP growth of only 1.5% in the 1Q and 1.9% for all of 2012. Goldman Sachs revised its estimate of 1Q GDP for the second time last week to below 2%.

The BCEI consensus on the unemployment rate for all of 2012 is 8.3%, followed by 7.9% in 2013. The official unemployment rate for February will be released this Friday, and the pre-report consensus is 8.3%. As explained by Abbott & Costello in last week’s E-Letter, the real unemployment rate is around 16% if we include those who have stopped looking for work.

The number of people filing for new unemployment benefits fell fairly significantly over the last month with initial claims of 351,000 in the week ended Feb. 25 and 353,000 the week before. If indeed the economy is growing slower than in the 4Q the recent dip in initial claims may be bottoming at these levels.

On the bright side, the Consumer Confidence Index rose to a much better than expected 70.8 in February, up from 61.5 in January, the highest reading in a year. The University of Michigan Consumer Sentiment Index also rose to 75.3 in February, up from 72.5 earlier in the month. The Conference Board’s CEO Confidence Index rose by 7.0 points in the 4Q, from 42 to 49 (a reading of more than 50 points reflects more positive than negative responses).

In other economic reports of late, perhaps the biggest surprise was in new orders for durable goods which plunged 4.0% in January. That’s a very big swing following the increase of 3.2% in December. The number was expected to fall by around 1.3% due to the expiration of a tax credit for businesses at the end of December, but 4% was quite a surprise.

Retail sales and personal spending were both modestly higher in January, but both were below the pre-report consensus. On the manufacturing front, the ISM Index for February, which was expected to rise, actually fell to 52.4, down from 54.1 in January.

On the housing front, US home prices fell in December from a month earlier, ending 2011 at the lowest levels since the housing crisis began in mid-2006, according to the Case-Shiller home-price indexes.  During the 4Q, home prices reached new lows, falling 3.8% sequentially and 4% year-to-year. Prices are down 33.8% nationally from their peak in the 2Q of 2006.

The BCEI consensus for inflation this year is 2.1%. I find that number to be optimistic, especially since the CPI was up 2.9% for the 12 months ended January. If oil prices remain above $100 per barrel, I don’t see inflation averaging only 2.1% this year. As this is written, crude oil is near $105.

Bernanke Defends Quantitative Easing

In testimony before the Senate Banking Committee last week, Fed Chairman Ben Bernanke predicted that the US economy will see “modest growth” this year. Many interpreted this as a signal that there will not be another round of quantitative easing, or QE3. When questioned about the positive effect of QE2 which began in late 2010, Bernanke noted:

"But since November 2010, we have had… the QE2 and the so-called Operation Twist, we have had about 2-1/2 million jobs created, we have seen big gains in stock prices, we have seen big improvements in credit markets, the dollar is about flat, commodity prices excluding oil are not much changed, inflation is doing well in the sense that we are looking for about a 2 percent inflation rate this year.”

As noted above, I think 2% inflation this year is quite optimistic, especially if oil prices remain above $100 per barrel. Bernanke also noted that the Fed is no longer worried about deflation as it was in 2010 and said that the economy is: “back to a more stable inflation environment.”

Perhaps the only surprise in Bernanke’s testimony was when he warned that the US recovery could come off the rails in late 2012 if Congress fails to take action to address a massive fiscal cliff” of tax increases and mandatory spending cuts due to kick in in 2013. He noted: “I hope that Congress will look at that and figure out ways to achieve the same long-run fiscal improvement without having it all happen at one date.”

As always, Bernanke warned the Senators that the US is on an “unsustainable fiscal path” and if it continues, we will face a “fiscal and financial crisis.” As for European risks, Bernanke said that most large US banks have exposure to European sovereign debt, but that most of that debt is “well hedged” (we’ll see). All in all, not much new from the Fed Chairman.

Heritage Foundation: The Truth Behind High Gas Prices

As noted earlier, being in the business I am people frequently ask me why gasoline prices are so high. More recently, people have also been asking me if President Obama has any idea whatsoever about how the energy markets work. As it turns out, the Heritage Foundation just released an excellent report that addresses both questions. It also lists five specific actions that Congress and the Obama administration should undertake to increase energy production in this country. Enjoy.

QUOTE: The national average for gas prices is almost $3.60 per gallon, increasing 40 cents from a year ago and jumping 20 cents from just one month ago. Prices are already surpassing $4 per gallon in some states and could threaten the country’s economic recovery. Higher gas prices drive up production costs for goods reliant on transportation, and more money spent at the pump means less money spent at restaurants and movie theaters. Buying fewer goods and services tightens the economic vice and holds back job creation.

Almost 70 percent of the price of gasoline comes from the price of crude oil, with excise taxes, refining costs, and retail/distribution making up the other 30 percent. Exporting refined petroleum products comprises a small percentage of total domestic gas production and marginally impacts prices. Despite demand for oil falling in the United States as a result of a weaker economy and a warm winter curbing the use of heating oil, the industrial rise of China and India continue to put upward pressure on the price of oil. The threat of Iran restricting oil exports to Europe is also driving up the global price, impacting gas prices in the U.S.

President Obama addressed these issues Thursday, February 23, in a speech on gas prices in which he continued to take many facts out of context. While the President said that there is no quick fix to high gas prices and the nation cannot drill its way out of the problem, he creates a false dichotomy that suggests that micromanaging the solution from Washington by subsidizing uneconomical technologies and sources of energy would work. This approach would do little to provide America with new, reliable, and economical sources of energy and in fact would cause more harm than good to the consumer and taxpayer.

America knows what works to effectively combat high gas prices: allowing the market to work by opening access to the country’s own oil and gas reserves, reducing onerous regulations, and allowing producers and consumers to respond to energy prices without Washington’s interference. Here are five half-truths that one continually hears about gas prices and five actions that Congress and the Administration can take to effectively combat high gas prices.

Half-truth #1: Oil production is the highest it has been in eight years.

Increased oil and gas production in the U.S. is a great development, but this is a result of increased production on private lands in North Dakota, Texas, and Alaska. On federal lands and offshore, the story is much grimmer. Production on federal lands and offshore could have yielded more output, increasing supply and therefore putting downward pressure on oil prices. Poor administrative decisions—such as refusing to open areas to exploration and production, cancelling or delaying lease sales, and the offshore drilling moratorium and subsequent “permitorium”—significantly reduced oil production, destroying jobs and reducing economic activity in the process.

If there is an economic interest to produce this oil, Washington should allow companies to do so. In North Dakota, oil production is booming and unemployment is low. There should be more stories like this.

Half-truth #2: Increasing oil production takes too long and would not impact the market for at least a decade.

This has been the mantra of the anti-drilling crowd for years, and the longer politicians listen to the message, the longer the nation’s oil resources will remain undeveloped. If access to areas that are currently off limits is increased, it will take time to explore and extract that oil. But that does not change the fact that the nation needs it today and also in the future. Furthermore, some of this oil can reach the market in much less than a decade if the permitting process is streamlined and the Keystone XL pipeline—which could bring up to 830,000 barrels of oil per day from Canada to the Gulf Coast refineries—is built.

Half-truth #3: Oil is not enough. America has only 2 percent of the world’s oil reserves.

President Obama frequently uses this number to push federal investments in alternative sources of energy that cannot stand the test of the market. The reality is that he uses this number deceptively. According to the Institute for Energy Research:

Although the U.S. is said to have only 20 billion barrels of oil in reserves, the amount of oil that is technically recoverable in the U.S. is more than 1.4 trillion barrels, with the largest deposits located offshore, in portions of Alaska, and in shale in the Rocky Mountain West. When combined with resources from Canada and Mexico, total recoverable oil in North America exceeds 1.7 trillion barrels, or more than the world has used since the first oil well was drilled over 150 years ago in Titusville, Pennsylvania. To put this in context, Saudi Arabia has about 260 billion barrels of oil in proved reserves.

One reason to view “reserves” estimates with caution is the fact that they are constantly in flux. In 1980, the U.S. had oil reserves of roughly 30 billion barrels. Yet from 1980 through 2010, it produced over 77 billion barrels of oil. In other words, over the last 30 years, the U.S. produced over 150 percent of the proved reserves that it had in 1980. If the massive quantities of U.S. oil are made available to explore and produce, the current estimated reserves of 20 billion barrels would certainly increase, providing much more production over decades to come. In other words, reserves are not a stagnant number.

Half-truth #4: Oil is not enough. The country needs an “all-of-the-above” approach to reduce its dependence on oil.

President Obama mentioned this approach in his 2012 State of the Union address, saying, “This country needs an all-out, all-of-the-above strategy that develops every available source of American energy.” But a market-based strategy is the only all-of-the-above approach. It allows all energy sources to compete, drives innovation, and results in the best possible supply and pricing. Sadly, all-of-the-above is often just an excuse to subsidize uneconomical and politically preferred technologies and energy sources, which leads to a “pigs-at-the-trough” strategy.

Whether they are for biofuels, electric vehicles, or natural gas vehicles, subsidies for alternative fuel and vehicle technologies waste taxpayer dollars, misallocate labor and capital, and create a dependence on government that promotes crony capitalism. The world petroleum market is a multi-trillion-dollar one; whatever technology can capture a portion of that market will not need help from taxpayers.

Half-truth #5: Speculators are driving up the price of gas, and they need to be reined in.

Finger-pointing at speculators and investigating prices at the pump ignore the real cause of rising gas prices: supply and demand. Oil futures markets can affect prices at the pump by changing the amount of gasoline delivered to gas stations. If producers anticipate higher prices in the future, they might take some oil off the market today and wait to sell it later. This may be happening to some degree (although there has been little historical evidence of this), especially given Iranian threats to cut off supply to European markets, but it would cause only a marginal short-run increase in prices, because at some point businesses have to unload the inventories they accumulate.

Five Actions for Congress and the Administration

Congress and the Administration should:

  1. Get moving on permits. As the only country in the world that places a majority of its territorial waters off-limits to oil and gas exploration, the U.S. should at the very least be drilling in the areas where access is permitted. Removing the de facto moratorium on drilling would immediately increase supply, create jobs, and bring in royalty revenue to federal and state governments.
  2. Require lease sales when ready. Congress should open areas that are off-limits: the eastern Gulf of Mexico, the Atlantic and Pacific coasts, Alaska’s offshore, the Alaska National Wildlife Refuge, and lands out West. Congress should require the Secretary of the Interior to conduct lease sales if a commercial interest exists to explore and drill. Congress should also provide the funding necessary to lease new onshore and offshore areas to oil and gas companies. Although it would take time for the federal government to lease these areas and for the energy companies to develop them, at least the process could begin.
  3. Create a sensible review processes. Placing a 270-day time limit on environmental reviews would ensure a quick review process for energy projects on federal lands. Construction projects on federal lands take an average of 4.4 years. The 270 days would allow for a thorough environmental review process but would not prevent investments from moving forward.
  4. Remove regulatory delays and limit litigation. Environmental activists delay new energy projects by filing endless administrative appeals and lawsuits. Creating a manageable time frame for permitting and for groups or individuals to contest energy plans would keep potentially cost-effective ventures from being tied up for years in litigation while allowing the public and interested parties to voice opposition or support for these projects.
  5. Approve the Keystone XL Pipeline. Congress should use its authority to regulate commerce with foreign nations to accept the State Department’s conclusion that construction of the pipeline would pose minimal environmental risk.  Approving the pipeline would create jobs and increase energy production—both of which the nation desperately needs—from a friendly supplier and ally.

Let the Market Work

The market would respond if Congress and the Obama Administration allowed it to work. Oil companies would respond by increasing their production, and consumers would switch to more fuel-efficient cars without any need to mandate more fuel-efficient trucks and cars. If the price of gasoline continues to rise, it will make alternative technologies all the more economically competitive. But policies that restrict oil exploration, refining, and production should not artificially drive that price higher. END QUOTE

How US Could Become World’s Largest Energy Producer

Along the same line, I read another excellent report from Mark Kiesel at PIMCO last week. It’s a very good read and includes a number of interesting graphics. Here’s just one quote from the article to whet your appetite:

“In combination, we believe increasing natural gas and onshore oil production could potentially see the U.S. overtake Russia as the world’s largest energy producer in the next ten years, and over time America should make great progress in becoming more energy self-sufficient as a nation.”

CLICK HERE to read the full article.

Best personal regards,

 

Gary D. Halbert

 

Be sure to read Gary's blog Between the Lines for news and information that has an impact on your bottom line.

 

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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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