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Made in the USA: The Causes of High Oil Prices
By Philip K. Verleger, Jr.
PKVerleger LLC, May 15, 2008
This is how Bush caused oil prices to go up
Exactly one year ago today, crude oil traded for $50 per barrel, almost 50 percent below the
current price. At the time, the petroleum press noted the “massive” $12-per-barrel decrease
recorded since the first of the year. Experts ruminated about growing stock levels that threatened
further declines. Governments of oil-exporting nations cut budgets to reflect lost revenues.
Today, the situation in oil markets one year ago seems to have happened in another world.
Oil prices doubled from January 2007 to January 2008. As they rose, inventories declined. And
as prices surged, governments of oil-exporting countries revised their budgets to exploit the
windfall.
The price rise, to most people, is a mystery. Oil markets were not shaken by international
events in 2007. No leader of a major oil-exporting country was assassinated. No major oil-
exporting nation experienced a revolution. No major oil-producing facility was destroyed by
earthquakes or other natural disasters. To the contrary, the global situation seemed to improve
over 2007.
There was also no consumption “surprise.” While use rose to a modest extent during 2007,
pulled higher by countries like China, the rise was expected and within historical experience.
Aggregate market conditions do not, in short, explain the price doubling. Oil prices today
should be between $50 and $70 per barrel. So what happened?
In my view, two energy policy actions drove prices to nearly $100 in 2007. Left unchanged, these actions will take prices higher in 2008 ($127 in May 2008). The first policy act was the imposition of new regulations requiring removal of almost all sulfur from diesel fuel and gasoline in the United
States, Europe, and some Asian countries.
Over the last decade, environmental officials across the world have forced refiners to cut sulfur in gasoline and diesel. Last year the U.S. extended rules requiring less than 10 parts per million of sulfur to most diesel fuels. This January similar standards for gasoline went into effect in the EU. Those living in urban areas have and will continue to enjoy enormous environmental benefits from these new regulations.
Refiners have met these new requirements by investing in sulfur removal equipment. Their
record over the last ten years has been remarkable. The investment has enabled them to produce
low-sulfur products from crude feedstocks with very high sulfur content. In addition, though, the
regulations have created a stronger demand for very-low-sulfur crude oils. Low-sulfur crudes
(those containing less than 0.5 percent sulfur) can be processed into low-sulfur products more
easily than high-sulfur crudes.
Absent other changes, the imposition of the new regulations would have added a modest
upward bias to crude prices – but it certainly would not have taken oil to $100 per barrel (in 2007 and $127 in 2008).
By Philip K. Verleger, Jr.
PKVerleger LLC, May 15, 2008
This is how Bush caused oil prices to go up
Exactly one year ago today, crude oil traded for $50 per barrel, almost 50 percent below the
current price. At the time, the petroleum press noted the “massive” $12-per-barrel decrease
recorded since the first of the year. Experts ruminated about growing stock levels that threatened
further declines. Governments of oil-exporting nations cut budgets to reflect lost revenues.
Today, the situation in oil markets one year ago seems to have happened in another world.
Oil prices doubled from January 2007 to January 2008. As they rose, inventories declined. And
as prices surged, governments of oil-exporting countries revised their budgets to exploit the
windfall.
The price rise, to most people, is a mystery. Oil markets were not shaken by international
events in 2007. No leader of a major oil-exporting country was assassinated. No major oil-
exporting nation experienced a revolution. No major oil-producing facility was destroyed by
earthquakes or other natural disasters. To the contrary, the global situation seemed to improve
over 2007.
There was also no consumption “surprise.” While use rose to a modest extent during 2007,
pulled higher by countries like China, the rise was expected and within historical experience.
Aggregate market conditions do not, in short, explain the price doubling. Oil prices today
should be between $50 and $70 per barrel. So what happened?
In my view, two energy policy actions drove prices to nearly $100 in 2007. Left unchanged, these actions will take prices higher in 2008 ($127 in May 2008). The first policy act was the imposition of new regulations requiring removal of almost all sulfur from diesel fuel and gasoline in the United
States, Europe, and some Asian countries.
Over the last decade, environmental officials across the world have forced refiners to cut sulfur in gasoline and diesel. Last year the U.S. extended rules requiring less than 10 parts per million of sulfur to most diesel fuels. This January similar standards for gasoline went into effect in the EU. Those living in urban areas have and will continue to enjoy enormous environmental benefits from these new regulations.
Refiners have met these new requirements by investing in sulfur removal equipment. Their
record over the last ten years has been remarkable. The investment has enabled them to produce
low-sulfur products from crude feedstocks with very high sulfur content. In addition, though, the
regulations have created a stronger demand for very-low-sulfur crude oils. Low-sulfur crudes
(those containing less than 0.5 percent sulfur) can be processed into low-sulfur products more
easily than high-sulfur crudes.
Absent other changes, the imposition of the new regulations would have added a modest
upward bias to crude prices – but it certainly would not have taken oil to $100 per barrel (in 2007 and $127 in 2008).
However, there was another change. The
U.S. Department of Energy resumed adding sweet
crude to the Strategic Reserve (SPR) in August 2007. At the time, crude prices were $70 per
barrel. DOE’s decision ignited the rise toward $100. On the heels of its “success,” DOE
announced it would double the input rate of sweet crude into the SPR beginning this month. In
effect, the price rise has been Made in America.
Prices of sweet crude increased for two reasons. First, the supply is very limited. Second,
refiners are willing to pay a very high price for it because it is so useful in making products
meeting new environmental specifications. (In economic terms, the price elasticity of demand is
very small.)
Tragically, neither DOE nor EPA conducted economic analyses before they decided to add oil
to the SPR. The head of DOE’s analysis group testified in December that the Energy Information
Agency had not studied the impact of that decision. Nor has DOE bothered to assess the effect of
the new environmental regulations on the crude market. Instead, department officials say they are
“surprised” prices have doubled.
The Bush administration can ease upward pressure on prices by altering its SPR policy. DOE
need not release oil from the reserve or even stop filling it. It needs only to stop inputting sweet
crude. I believe crude prices would ease dramatically were this to happen, possibly to $70 per
barrel.
Recently, White House Press Secretary Dana Perino said the government would not release
crude from the SPR because President Bush does not believe in manipulating markets.
Unfortunately, Perino misspoke. The Bush administration has been manipulating the world crude
market since it began adding sweet crude to the SPR in August 2007. Prices will fall if and when
President Bush stops this activity.
crude to the Strategic Reserve (SPR) in August 2007. At the time, crude prices were $70 per
barrel. DOE’s decision ignited the rise toward $100. On the heels of its “success,” DOE
announced it would double the input rate of sweet crude into the SPR beginning this month. In
effect, the price rise has been Made in America.
Prices of sweet crude increased for two reasons. First, the supply is very limited. Second,
refiners are willing to pay a very high price for it because it is so useful in making products
meeting new environmental specifications. (In economic terms, the price elasticity of demand is
very small.)
Tragically, neither DOE nor EPA conducted economic analyses before they decided to add oil
to the SPR. The head of DOE’s analysis group testified in December that the Energy Information
Agency had not studied the impact of that decision. Nor has DOE bothered to assess the effect of
the new environmental regulations on the crude market. Instead, department officials say they are
“surprised” prices have doubled.
The Bush administration can ease upward pressure on prices by altering its SPR policy. DOE
need not release oil from the reserve or even stop filling it. It needs only to stop inputting sweet
crude. I believe crude prices would ease dramatically were this to happen, possibly to $70 per
barrel.
Recently, White House Press Secretary Dana Perino said the government would not release
crude from the SPR because President Bush does not believe in manipulating markets.
Unfortunately, Perino misspoke. The Bush administration has been manipulating the world crude
market since it began adding sweet crude to the SPR in August 2007. Prices will fall if and when
President Bush stops this activity.
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