Economic Myth Busted: In the US, Savings from Lower Gas Prices was Spent on even More Gas!

Remember the popular mantra/incantation “low oil prices equals more consumer spending”? (this applies not only to the US but elsewhere including Philippines too)

Well, in the US, a study debunks the popular myth: savings from lower gas prices was spent on even more gas!

And bizarrely, media and ‘experts’ blame such unexpected course of development on human irrationality!

From the New York Times  (bold mine)

When gas prices fall, Americans reliably do two things that don’t make much sense.

They spend more of the windfall on gasoline than they would if the money came from somewhere else.

And they don’t just buy more gasoline. They switch from regular gas to high-octane.

A new report by the JPMorgan Chase Institute, looking at the impact of lower gas prices on consumer spending, finds the same pattern as earlier studies. The average American would have saved about $41 a month last winter by buying the same gallons and grades. Instead, Americans took home roughly $22 a month. People, in other words, used almost half of the windfall to buy more and fancier gas.

This is not rational behavior. Americans spent about 4 percent of pretax income on gas in 2014. One might expect them to spend about the same share of any windfall at the pump — maybe a little more because gas got cheaper. Instead they spent almost half.

Americans, in short, have not been behaving like the characters in economics textbooks…

The study, based on the spending patterns of about one million JPMorgan customers, does not track the kind of gas consumers purchased. It shows that people bought more gas as prices fell, and that the increase in consumption is not sufficient to explain the entirety of the increase in spending on gas.

Here is what the law of demand says “all else being equal…as the price of a product decreases, quantity demanded increases.” 

"People bought more gas as prices fell..."

Have consumers not been “behaving like the characters in economics textbooks”? Really? Or have consumers not been behaving in accordance to the fictitious outcomes generated from econometric models?

Of course, such econometric models have been constructed principally on the assumptions that humans DO NOT act based on ever changing preferences and values, in the face of an equally dynamic complex environment, that shapes incentives and consequently their actions. Or in short, for the math pedagogues, humans are NOT humans but automatons or robots whose actions are programmed.

But one may retort, they shifted from “regular gas to high-octane gas”.

So why not? Perhaps high octane gas could have been seen as more "energy efficient" (more fuel savings or longer driving mileage). If so then this reinforces, the law of demand.

But refuting the mythological gas-savings-equal-to-consumption-binge meme goes beyond the statistical technicalities.

Yet as I have noted here and many times elsewhere: the economics of spending is MAINLY a derivative of INCOME conditions—secondarily the utilization of savings and of credit—and NOT from the changes in spending patterns or the redistribution of spending from static income.

And as for the perspective of economic punditry versus real world phenomenon, the great Ludwig von Mises warned (Misapprehended Darwinism, Refutation of Fallacies, Omnipotent Government p.120)

Nothing could be more mistaken than the now fashionable attempt to apply the methods and concepts of the natural sciences to the solution of social problems. In the realm of nature we cannot know anything about final causes, by reference to which events can be explained. But in the field of human actions there is the finality of acting men. Men make choices. They aim at certain ends and they apply means in order to attain the ends sought.

Now whose behavior have not been rational…acting humans or ‘experts’ whose views have been shaped by rigid econometric models?

Quote of the Day: Economic output as weapons of national policy

All nations seem to assume that a public energy policy will bring their citizens and industries cheaper and more stable energy.  The opposite, of course, always happens.  This is just the latest example of government meddling in a key sector of the economy.  Germany’s government has chosen to close its nuclear plants.  It subsidizes windmills.  Germany’s green movement is very powerful and exerts a negative influence on Germany’s ability to exploit domestic energy sources through new techniques, such as fracking.  As a result, energy prices in Germany are approximately double those of the US and it is dependent upon supplies from political dictatorships like Russia.

In a free market for energy firms would rush to fill energy orders when a rival supplier appeared to be unreliable.  In a free market for energy a Russian cut off of natural gas would result in a permanent loss of customers to rival suppliers.  The current situation is made worse by US law that prohibits exports of natural gas.  In an unhampered market, US firms would be free to sell gas to the highest bidder and there is little doubt that Europe would negotiate alternative sources with a threatened Russian supply cutoff.  A Russian embargo would permanently damage its natural gas industry by proving it to be an unreliable supplier, costing it the loss of business for many, many years.

Unfortunately, all nations use the economic output of their citizens and firms as weapons of national policy, even in the absence of war.  The result is the opposite of their intentions, which should surprise no one.

This is from Patrick Barron at the Ludwig von Mises Canada.

It's sad to see how most people have been deceived to see governments as the answer to social problems, when in reality, governments have been the major sources of the vast majority of society's ills. Worst is that the public have been unwittingly held hostage by many governments, where in the latter's desire to force their will upon other governments, increases the risks of military conflicts or wars. In short, the more the politicization of resources, the greater the risks of violent (inhumane) outcomes.

Quote of the Day: Syrian war is a fight by the U.S. to maintain its top-dog status

The U.S. as global superpower is made possible by the dollar being the world’s reserve currency. And supporting the dollar’s role as world’s reserve currency is the fact that global energy transactions take place through the dollar. Energy is what gives the U.S. dollar and America their power.

Russia and Iran have no real intention of maintaining the status quo. Longer term, neither does China. Saudi Arabia long ago decided to support the dollar by selling its oil for depreciating greenbacks, which is why the two are such strong allies.

So what you’re seeing in Syria is not another regional conflict. It’s a fight by the U.S. to maintain its top-dog status. But when dogs get in trouble, they’ll do anything to survive. They’ll even gnaw off their leg if they get it trapped.

From Greg Canavan at the Laissez Faire Books

First Shale Gas Output from China, India to Follow

I previously pointed out that, the Southeast Asian territorial dispute has NOT been about oil as popularly thought.

And since China has the largest reserves of Shale energy in the world, like the US, dependence on external sourcing of oil WILL diminish. So there hardly is any need or incentive for gunboat diplomacy (except to use this as diversion for other unstated reasons).

Also I pointed out that Shale gas revolution is the future of energy which should translate to a worldwide phenomenon.

I would guess that the shale gas revolution will be a worldwide phenomenon which should wean away our dependence on oil. The net effect outside manipulation of money by governments should be to materially bring down or lower prices of energy.

Now some confirmations to this prediction: China will be having its first shale gas output while India is slated to access local Shale energy too.

The roll out of Asia’s shale gas boom has began!

From Bloomberg (bold emphasis mine)

ONGC, India’s biggest explorer, is studying data for shale- gas deposits and awaiting a government policy on commercial drilling for gas trapped in shale rock, Sudhir Vasudeva, chairman of the state-run company, said in a telephone interview yesterday. China Petrochemical Corp. will start pumping the nation’s first shale gas from a project in Sichuan province next month, according to a report on Caixin’s website on May 15, citing the company…

India holds 6.1 trillion cubic feet of technically recoverable shale gas reserves in three basins, the U.S. Geological Survey estimated in a report in January. That was less than 10 percent of the 63 trillion cubic feet estimate made the previous year, in April, by the U.S. Energy Information Administration in a report.

“The U.S. estimates are just estimates, and we’ll have to survey the geology and deposits and drill wells before we know how much shale gas we have,” Vasudeva said. “What we do know is that India does have shale-gas reserves.”

ONGC found shale gas at a well in India’s West Bengal state, according to a Jan. 27, 2011, statement. The company signed an agreement with ConocoPhillips (COP) on March 30 for developing shale resources in India and North America.

India Auction

India has started mapping its shale resources and will have exploration rules in place by 2013, Prime Minister Manmohan Singh said March 23. Blocks will be auctioned next year after the policy is published, G.C. Chaturvedi, the top bureaucrat in the oil ministry, said Dec. 21…

China has 25.08 trillion cubic meters (886 trillion cubic feet) of exploitable onshore shale-gas reserves, the country’s land ministry said March 1. The world’s biggest energy consumer aims to produce 6.5 billion cubic meters of shale gas by 2015 and set a target of 60 billion to 100 billion cubic meters by 2020, the National Development and Reform Commission said.

China Shale

China drilled 50 shale-gas wells in the past year, compared with 1,300 a month in the U.S., Chris Faulkner, chief executive officer of Breitling Oil and Gas Corp., said April 23. It takes “three to five years” for a shale-gas discovery to start commercial production and an extensive pipeline network is needed to transport the fuel to consumers.

My comments

This should serve as more proof that shale gas is the future of energy.

This also means that the emphasis for acquiring energy reserves will largely be directed to Shale at the expense of alternatives (conventional oil, coal, nuclear, solar, wind)

And this is why energy geopolitics will shift to Shale.

My favorite environmental science and economics author Matt Ridley writes

The campaign to stop shale gas proving its case in the market is political, not scientific. Behind it lies vested interests. The Russian gas industry, which is alarmed at losing its impending near-monopoly on European gas supplies, has been vocal in its criticism of shale gas. The coal and nuclear industries too would like to see this baby strangled at birth, but have been less high-profile.

Most of the opposition, though, has come from those with a vested interest in renewable energy, including the big environmental pressure groups, which are alarmed that the rich subsidies paid to wind, biomass and solar may be under threat if gas gets too cheap and cuts carbon emissions too effectively. Their entire rationale for subsidy, parroted by their dutiful poodle Chris Huhne, when Energy Secretary, is that gas would get more expensive until even wind and solar looked cheap. That was wishful thinking.

Even if you do not think carbon emissions are the highest environmental priority, there is a more fundamental reason why using gas is good for the planet. No other species needs or uses it. Every time you grow a biofuel crop, harvest timber for a biomass power station, pave a desert with solar panels or dam a river for a hydro plant, you are stealing energy from the natural world. Even the wind is needed - by eagles for soaring, by bats for feeding (both are regularly killed by wind turbines). As the only species that uses gas, the more we use it the more we can leave other sources of energy for nature.

And lastly, given all of the above, this is further evidence that many have seduced to the quackery, peddled by politicians and mainstream media, that the Southeast Asian territorial disputes of Scarborough or Spratlys has been about oil.

As a side note, Japan and China has their version of territorial dispute through Senkaku Islands which I earlier pointed out. Yet, in spite of the supposed bickering, Japan-China-South Korea concluded last week what has been labeled as the "Trilateral Summit" covering vast economic and political issues

Part of the rapprochement reached from the conference as noted by Xinhua, ironically China’s official press agency:

On strengthening communication and coordination in regional and international affairs, they stressed the mutually reinforcing and complementary roles of the trilateral cooperation and such regional fora as ASEAN Plus One, ASEAN Plus Three, East Asia Summit, ASEAN Regional Forum and Asia-Pacific Economic Cooperation, said the declaration.

They reaffirmed that the ASEAN Plus Working Groups need to be established without delay to accelerate the discussion on a regional comprehensive economic partnership towards the commencement of negotiations, taking into account the initiatives of East Asia Free Trade Area (EAFTA) and Comprehensive Economic Partnership for East Asia (CEPEA).

So again, the Philippines either has a Dr. Jekyl and Mr. Hyde relationship with China or that all the ruckus about the gunboat diplomacy has been geopolitical vaudeville.

Shale Oil Discoveries Goes International, Easing Peak Oil Concerns

Last week, Argentina and China reported major Shale oil discoveries

From Presstv.com

Argentina's YPF oil and gas company has announced a historic oil discovery in the country's southern province of Neuquen, Press TV reports.

Yacimientos Petroliferos Fiscales (YPF) new finding includes 927 million barrels of recoverable oil and natural gas, of which 741 million barrels is shale oil.

“They [YPF] have an important discovery, and they have to expand it. The major challenge is to develop the technology and raise the capital in order to produce at reasonable prices,” Daniel Gerold, an energy market analyst told Press TV.

From Independent.co.uk

The shale gas revolution spread to China yesterday as Royal Dutch Shell struck the rock-based fossil fuel while drilling, heralding the country's first commercial production.

In a joint venture with its local partner, PetroChina, Shell has drilled two wells and discovered a good flow of gas.

"It's good news for shale gas," said Professor Yuzhang Liu, vice president of Petrochina's Research Institute of Petroleum Exploration and Development. Shale gas is fraught with controversy because it is extracted from the rock with blasts of sand, water and chemicals through a process known as hydraulic fracturing, or fracking, that has been linked to earthquakes and water pollution.

However, the discovery of vast quantities of the gas in countries such as the US, Poland and the UK has the potential to provide a relatively cheap, secure source of energy.

In April, the US Energy Information Administration estimated that China may hold 1,275 trillion cubic feet of shale gas, 12 times its conventional gas reserves and almost 50 per cent greater than in the US.

With the spate of Shale oil discoveries which should be expected to increase, as I previously wrote,

Eventually the growth of the industry will likely reach a scale enough to incentivize a structural change or reconfiguration in the distribution of demand.

This implies an easing of relevance of peak oil.

From Platts.com,

The debate over whether the world's reserves of hydrocarbons have now peaked and are in decline has lost relevance over recent years as new technology allows oil companies to find and exploit new hydrocarbon sources, the CEO of Repsol Antonio Brufau said Tuesday.

Brufau said progress made in exploring and developing ultra-deepwater areas, unconventional oil and gas sources and the move into remote areas such as the Arctic, have been key to growing global reserves of oil and gas.

"The speed at which technology changes and its consequences have taken us largely by surprise. The peak oil debate, for example, has lost a great deal of its relevance in the past three years," Brufau told the World Petroleum Congress in Doha.

"The possibility that usable resources under commercially viable terms will run out is no longer a concern in the short or medium term," he said.

(Hat tip Professor Mark Perry)

Why Shale Gas is the Future of Energy

So argues the ever stimulating author Matt Ridley

A chap called George Mitchell turned the gas industry on its head. Using just the right combination of horizontal drilling and hydraulic fracturing (fracking) – both well established technologies -- he worked out how to get gas out of shale where most of it is, rather than just out of (conventional) porous rocks, where it sometimes pools. The Barnett shale in Texas, where Mitchell worked, turned into one of the biggest gas reserves in America. Then the Haynesville shale in Louisiana dwarfed it. The Marcellus shale mainly in Pennsylvania then trumped that with a barely believable 500 trillion cubic feet of gas, as big as any oil field ever found, on the doorstep of the biggest market in the world.

The impact of shale gas in America is already huge. Gas prices have decoupled from oil prices and are half what they are in Europe. Chemical companies, which use gas as a feedstock, are rushing back from the Persian Gulf to the Gulf of Mexico. Cities are converting their bus fleets to gas. Coal projects are being shelved; nuclear ones abandoned.

Rural Pennsylvania is being transformed by the royalties that shale gas pays (Lancashire take note). Drive around the hills near Pittsburgh and you see new fences, repainted barns and – in the local towns – thriving car dealerships and upmarket shops. The one thing you barely see is gas rigs. The one I visited was hidden in a hollow in the woods, invisible till I came round the last corner where a flock of wild turkeys was crossing the road. Drilling rigs are on site for about five weeks, fracking trucks a few weeks after that, and when they are gone all that is left is a “Christmas tree” wellhead and a few small storage tanks.

The International Energy Agency reckons there is quarter of a millennium’s worth of cheap shale gas in the world. A company called Cuadrilla drilled a hole in Blackpool, hoping to find a few trillion cubic feet of gas. Last month it announced 200 trillion cubic feet, nearly half the size of the giant Marcellus field. That’s enough to keep the entire British economy going for many decades. And it’s just the first field to have been drilled.

Read the rest here

Natural Gas prics shown in the 3 year chart above from stockcharts.com appears to have indeed decoupled from Oil (WTIC)

I would even suppose that the current prices of oil have also been affected by conversions or the expanded use of natural gas.

Shale gas is not only abundant and economically feasible but also environmental friendly and importantly representative of market’s preference as energy alternative over the favorites of politicians: renewables

Professor Mark Perry adds,

The chart above is from the Energy Information Administration and illustrates graphically the significant increases in natural gas production in recent years from increased drilling activity in the Marcellus Shale region of Pennsylvania. In only about a three-year period, natural gas production in the northeast United States has tripled from 1.5 billion cubic feet per day in July 2008 to more than 4.5 billion cubic feet per day by July 2011, with almost all of the increase coming from new drilling in Pennsylvania. The shale gas revolution in Pennsylvania has been responsible for America going from the ninth largest producer in the world ten year ago to the No. 1 producer in the world starting last year.

I would guess that the shale gas revolution will be a worldwide phenomenon which should wean away our dependence on oil. The net effect outside manipulation of money by governments should be to materially bring down or lower prices of energy.

On an investment perspective, prices of listed shale gas companies may reflect on such sanguine dynamic overtime.

Phisix: Negative Real Interest Rate and Stagflation Risks

The real interest rate is not the difference between the nominal rate and the change in the CPI; it is actually the rate of exchange between present goods and future goods. Also, there is no such thing as the real interest rate — there are a multitude of real rates, which cannot be added to a total. -Frank Shostak

In sympathy with the actions in global markets, the Phisix declined 1.82% over the week which reduced year to date gains to .44%.

Negative Real Interest Rate and BSP’s Admission of External Influences

The Philippines and most of ASEAN have so far been less politically influenced relative to other markets.

But this doesn’t make us immune.

Proof?

From Bloomberg[1],

``Bangko Sentral will review inflation forecasts for this year and 2012 at the June 16 meeting, Tetangco said. An extension of the Federal Reserve’s so-called quantitative easing, “if it happens,” will tend to boost inflows to emerging- markets, bolster liquidity and strengthen currencies, he said.”

The good governor does not directly say it; but he implicitly acknowledges that there exists a strong transmission mechanism from US Federal Reserve policies, which have substantial effects on local assets, the local economy and inflation.

Governor Amando Tetangco thinks he has all the required tools to manage this.

I quote Governor Tetangco anew from the same article,

“If you look at the May figure, inflation pressures still exist,” Tetangco told reporters in Manila today. “We will look at the options available, the instruments included in the toolkit including the policy rate, reserve requirement and macro prudential measures.”

And I have been saying that local media and the BSP have not been forthright[2] and will miscalculate on estimating inflation trends.

This has been happening.

Nevertheless, the Philippines still operates on an accommodative monetary policy.

Previously, the Philippine (CPI) inflation rate, as shown in the chart from tradingeconomics.com[3], has been slightly above interest rates which make for a negative real interest rate environment[4], where inflation is greater than interest rates. In this article, I will be wearing on the mainstream’s thinking cap on interest rates.

So accounting gains from fixed income investments on a nominal basis could likely be overestimated unless adjusted for by inflation.

The Bangko Sentral ng Pilipinas (BSP) increased its policy interest rates twice this year but so far, the level of rates are just about the level of BSP’s statistical inflation.

Yet given the public’s outcry over price hikes in energy and food, I think that the mathematical construct of the BSP’s CPI basket seems to underreport real CPI inflation.

This only means that the current operating conditions imply that negative interest rate environment could be alot greater than what can be gleaned seen using BSP computations.

The overall implication, according to Wikipedia.org[5], is that negative real interest rates leads

to commodity speculation and business cycles, as the borrower can profit from a negative real interest rate

Also, given the combination of the current level of economic growth rate, which remains far above the interest rate, coupled with the negative real interest rate outlook, suggests that the Philippines continues to operate on a loose monetary inflation stoking environment.

Easy money policies which favor debtors also mean favoring speculators. Thus, current environment remains supportive of an upbeat Phisix, despite a current slowdown elsewhere.

So both external and internal forces in fusion points towards higher inflation which will go beyond the expectations and the statistical estimates of the BSP.

The Peso yield curve seems to be indicating the same inflation outlook (chart from ADB’s Asian Bonds Online[6])

Our current yield curve (red) has further steepened from last year (yellow) implying higher future inflation.

To add, going back to the economic growth, inflation and interest rate chart, despite the slowing growth momentum (measured in quarterly changes upper window), which is signified by the red arrow, the above dynamics seems representative of symptoms known as stagflation—high inflation accompanied by high unemployment and slower economic growth[7].

So this could be a preview of what’s going to happen once inflation intensifies.

Stagflation and the EPIRA law

Aside from local and foreign monetary policies, part of the worsening of domestic inflation has recently been seeded.

The passage or the extension of the politically correct but economically unfeasible decree signified by the massive electricity subsidies based on the Electric Power Industry Reform Act [EPIRA] law[8] will be part of such force. In 2010[9], I have previously discussed on how this would contribute to today’s inflation. Apparently we see signs of price pressures[10] part of which has been due to this.

These subsidies would intensify demand for electricity consumption, where the benefits of political free lunches aimed at acquiring votes, will only be passed and added to the burdens of all productive enterprises.

The outcome will reminisce the past where increasing costs of energy will translate to higher cost of doing business, elevated risk premiums and high hurdle rates that would imply fewer investments, higher levels of unemployment, lower growth rate and importantly lower standards of living.

Moreover, this law impels for the growing risk of power supplies shortages.

Eventually socialist type of free lunches runs dry. As former UK Prime Minister Margaret Thatcher says[11], Socialism

always run out of other people's money. It's quite a characteristic of them

Proof?

Venezuelan President Hugo Chavez claims that energy is a “birthright” for Venezuelans[12]. The result has been a massive rolling blackout, a model we should look forward to especially in the face of the continued uptrend in commodity and energy prices.

In addition, like Venezuela[13], we can expect more smuggling or black market or illegal connections to take place.

Indonesia has learned from such unviable and absurd policies and has begun dismantling subsidies to all sectors.

As the Jakarta Post reports[14],

The government expects to remove the electricity subsidy completely by as early as 2014 so that it will have more funds available to fight poverty and improve healthcare directly for the poor, a minister has said..

Unfortunately we have taken the opposite route.

Yet this is an example of redistributive tax scheme, where publicly listed Meralco, a legally franchised monopoly, would serve as the conduit for such mandate. This validates only my observation about Meralco’s status as a pet company for politicians[15].

The good news is that stagflation does not automatically translate to wreckage for the stock markets. Not if we use Venezuela as a model.

Venezuela has had an amazing stock market run this year[16] despite inflation tipping towards hyperinflation earlier, along with high unemployment and a two year economic slump which she has reportedly emerged from[17].

This is not to say that stagflation is good for the stock market, instead the returns of Venezuela’s stock markets remains negative when computed for inflation.

Put differently Venezuela’s stock market could have functioned as a defensive store of value from her rapidly devaluing currency.

The other point is that Venezuela’s dynamic may or may not apply elsewhere because of every nation’s idiosyncrasy or structural uniqueness.

For most, the current state of boom bust cycles, which drives global stock markets evinces that meltdowns are a mostly result of liquidity contraction from a previous inflationary environment such as the recent cases of Bangladesh[18] and Vietnam[19] or the global 2008 crisis.

PSE: It’s a Correction Phase

Last week’s correction seem as broadmarket based.

All sectors endured losses. Even the mining sector which has sizzled for 10 consecutive weeks finally relented.

The good news is that despite the losses, market breadth hasn’t been as dire as declining issues led advancing issues moderately.

Even net foreign trade posted slightly negative.

The Peso declined along with the local benchmark market, albeit only marginally lower from php 43.205 to a US Dollar last week to php 43.28 at Friday’s close.

Market internals and the Peso’s actions have not yet been manifesting signs of sharp deterioration.

Thus, I’d read the actions in the Phisix as a consolidation phase awaiting a trigger for a next run.

One would further note that the last time the Phisix collapsed was in an environment of higher rate of inflation and higher level of interest rates than today. Of course the 2008 episode accounted for as contagion which whose origins were from external forces.

The point is I don’t see substantial signs of severe corrosion of financial and economic conditions yet.

Finally, we should expect the continuance of current global volatility until political issues abroad would get threshed out.

As for the timing of when this resolution will happen is beyond my capabilities as analyst, I can only speculate.

As Ludwig von Mises wrote[20], (bold emphasis mine)

In the real world acting man is faced with the fact that there are fellow men acting on their own behalf as he himself acts. The necessity to adjust his actions to other people's actions makes him a speculator for whom success and failure depend on his greater or lesser ability to understand the future. Every action is speculation. There is in the course of human events no stability and consequently no safety.

And since I expect the current market actions to represent more of a countercyclical reprieve than a major inflection point, then it should be considered as windows of opportunities to accumulate or for trade.

---

[1] Bloomberg.com Philippines’ Tetangco Says Inflation Pressures ‘Still Exist’ (1), June 10, 2012

[2] See The Code of Silence On Philippine Inflation, January 16, 2011

[3] Tradingeconomics.com Philippine Indicators

[4] Investorglossary.com Real Interest Rates

[5] Wikipedia.org Negative Real Interest Rates

[6] Asianbondsonline.adb.org Philippines

[7] Wikipedia.org, Stagflation

[8] Businessworldonline.com Legislators OK extension of lifeline subsidy scheme, June 7, 2011

[9] See Earth Hour In The Philippines: Rotational Brownouts! The Revenge Of Economics, April 09, 2010

[10] Philstar.com Power, fuel rates up, April 6, 2011

[11] Thatcher Margaret TV Interview for Thames TV This Week 1976 Feb 5 Th

[12] Yahoo.com Hugo Chávez challenges Venezuelan 'birthright' to cheap gas, March 4, 2011

[13] Reuters Africa, World's lowest gas prices fuel Andean smuggling, June 10, 2011

[14] Jakarta Post, Govt expects to remove electricity subsidy by 2014, March 23, 2010

[15] See Meralco’s Run Reflects On The Philippine Political Economy, July 12, 2009

[16] See Global Equity Markets: Signs of Exhaustion; What US Outperformance Means, May 17, 2011

[17] Wall Street Journal 2nd UPDATE: Venezuela 1Q GDP Up 4.5% Vs Previous Year, May 17, 2011

[18] See Bangladesh Stock Market Crash: Evidence of Inflation Driven Markets, January 11, 2011

[19] See Vietnam Stock Market Plunges on Monetary Tightening, May 24, 2011

[20] Mises, Ludwig von UNCERTAINTY: Case Probability, Chapter 6 Section 4 Human Action

Why Electric Vehicles Won’t Sell

It’s basic economics at work

Researchrecap explains, (bold emphasis mine)

A new survey from Deloitte shows that 78 percent of consumers in the United States would consider purchasing an electric vehicle (EV) when fuel prices reach $5.00 per gallon. The study, Gaining traction: Will consumers ride the electric vehicle wave?, surveyed 12,000 consumers globally, including more than 1,000 in the US, and finds that the higher the price of fuel, the more interested consumers are in EVs.

“Offsetting the fuel factor is the finding that the better the fuel efficiency of internal combustion engine (ICE) vehicles, the less interested consumers become in EVs,” said Craig Giffi, vice chairman, Deloitte LLP and U.S. automotive practice leader. “A total of 68 percent of consumers in the U.S. and 57 percent in China are less likely to consider an EV if they are able to find ICEs with a fuel efficiency of 50 miles per gallon.”…

More than half of U.S. consumers surveyed are not willing to pay any price premium for an EV compared to a regular car (ICE) while only 8 percent are willing to pay a price premium of more than $3,000.

Moreover, the overwhelming majority of these consumers (77 percent) expect to pay less than $30,000 net of government incentives. In Europe and China however, it becomes an even more significant challenge as the majority of consumers expect to pay less than $20,000 for an electric vehicle and more than 50 percent of consumers in these markets refuse to pay any kind of price premium for an electric vehicle.

Consumers have continually been weighing on the tradeoff between utility “better the fuel efficiency of internal combustion engine (ICE) vehicles” and prices “when fuel prices reach $5.00 per gallon”.

Currently, fuel prices have not been high enough to sway consumers towards Electric Vehicles (EV). And this has been happening in spite of US government’s interventions (via incentives).

That’s because prices determine people’s actions, as Friedrich von Hayek wrote, (bold highlights mine)

prices are signals which enable us to adapt our activities to unknown events and demands, it is evidently nonsense to believe that we can control prices. You cannot improve a signal if you do not know what it signals.

Bottom line: government intervention has failed to modify people’s behavior. Prices will.

Saudi Arabia’s Unsustainable Welfare State

The Wall Street blog reports, (bold highlights mine)

Another reason to brace for higher oil prices in coming years: big oil exporters are increasingly dependent on the income.

Saudi Arabia, due to higher government spending this year, will need its oil to sell for $88 a barrel in 2011 for its government to break even–up from $68 last year, according to a new estimate from the Institute of International Finance, a global bankers’ trade group.

The kingdom, in response to the unrest spreading throughout the Middle East and North Africa, is boosting government spending to provide new social benefits for its people. The support for housing units, unemployment benefits and wage hikes for public workers (among a long list of measures) will contribute to a 31% increase in government spending in 2011 from a year earlier.

Aside from the prospects of reducing oil supply to allegedly generate more income (i.e. by manipulating markets), this exemplifies how the welfare state, which works for the benefit of a few, will NOT last.

Like substance abuse, bribing the citizenry would only grow overtime (from demographics and from the feedback loop of the deepening of the dependency culture--which translates to more demand for welfarism).

Importantly, this also shows how the welfare state contributes to inflation and to high oil prices, aside from showing more proof that the global oil markets are vastly manipulated and distorted from the ratchet effect (irreversible expansion) of government interventions.

Lastly like a house of cards, once oil prices collapse, Saudi’s political leadership will most likely suffer from a political backlash which may end their grip on power.

At the end of the day, Saudi’s welfare state could only buy the political leaders some time before the day of reckoning arrives. What is unsustainable won’t last.

The Political Folly of Energy Independence

Cato’s Economist Steve Hanke on the popular political drivel called “energy independence” (bold emphasis mine)

Every president since Richard Nixon has asserted that we are sitting ducks for those who brandish the oil weapon. To keep the evildoers at bay, the government must adopt policies that ensure our energy independence. Like his predecessors, President Obama is worshiping at this altar. And why not? How many elections have been lost by blaming foreigners for an impending crisis?

Despite their cynicism about politicians, most people actually believe that mineral resources, including oil, are doomed to disappear. It’s obvious: Start with a given stock of provisions in the cupboard, subtract consumption and eventually the cupboard will be bare.

But what is obvious is often wrong. We never run out of minerals. At some point it just costs too much to produce them profitably. In the 19th century, the big energy scare was in Europe. Most thought Europe was running out of coal. That doomsday scenario never materialized. Thanks to a plethora of substitutes, the prices that European coal could fetch today are far below its development and extraction costs. Consequently, Europe sits on top of billions of tons of worthless coal.

Once economics enters the picture, the notion of fixed reserves becomes meaningless. Reserves are not fixed. Proven oil reserves, for example, represent a warehouse inventory of the expected cumulative profitable output, not a fixed stock of oil thought to be in the ground.

When thinking about oil reserves, we must also acknowledge another economic reality: Oil is sold in a world market in which every barrel, regardless of its source, competes with every other barrel. Think globally, not locally. When we do, the dwindling reserves dogma becomes nonsense. In 1971, the world’s proven oil reserves were 612 billion barrels. Since then the world has produced approximately 990 billion barrels. We should have run out of reserves fourteen years ago, but we didn’t. In fact, today’s proven reserves are 1,354 billion barrels, or 742 billion barrels more than in 1971.

How could this be? Thanks to improved exploration and development techniques, costs have declined, investments have been made and reserves have been created. The sky is not falling.

Oil is just another economic good whose value is determined by the utility it provides. Thus like all economic goods, oil and energy products are subject to price sensitivity borne out of the forces of demand and supply and technological changes.

In other words, in contrast to naive views of neo-Malthusians, the economic value of oil is never fixed.

Proof of this has been man’s shifting use of energy from firewood to coal to whale oil to kerosene and now to the manifold derivative products of crude oil—gasoline, diesel, jet fuel and etc... That’s why while Peak oil is an engineering reality, Peak oil, as an economic concept, is a myth. Engineering does NOT capture human action.

Despite the recent rise in commodity prices, the real cost prices have been declining over the past 161 years!

Yet the recent price surges have partly been about consumptive demand (mostly imputed to emerging markets) but substantially also due to reservation demand (mostly identified as speculation).

The above graph reveals of the consumptive versus reservation demand from Bank of Japan.

The point is current imbalances of energy has been mainly caused by government interventions from artificial demand (quantitative easing programs, suppressed interest rates) to distortions on the supply side (geographical restrictions, price controls, subsidies, taxes and tariffs and etc).

Thus rising prices isn’t about energy dependency, peak oil and other interventionists babble, but about government failure.

The truth is that there is a cornucopia of commodities in the world as shown by the table from Brookenews. All it takes is for the market to discover and enable them to be commercially useful through price signals.

Yet neo-Malthusians interventionists believe in the fallacy where two wrongs equals a right. They address government intervention failure with even more government intervention, seeing that government is the be-all and end-all of human affairs.

Such political religion can be seen in the widespread celebration of the crass symbolism of the earth hour movement, whose anachronistic proposition is to regress human living standards back to medieval ages. It is more than a practise of atavism, it is an implied belief in misanthrope.

Of course people who fall for the energy independence idiocy simply disdain free trade. Such political blindspots are mainly rooted in the aversion to imports which is read as a mortal sin.

Yet what they preach is hardly what they practise. They don’t ever realize that by restricting the division of labor and comparative advantage, man regresses.

Say you hate fossil fuel? Then just walk or bike. Oh, since bike is also made out of fossil fuel, so just get a horse. But like the asinine shift to candlelight in order to project social conformity to earth hour, primitive means of transportation equates to more environmental hazards.

An example expressed by Gerard Jackson of Brookesnews,

The problem of coal smoke continued into the twentieth century when it was finally solved by the benefits of growth, which had already solved a multitude of other problems such as the tens of thousands of metric tonnes of horse manure that had to be taken from city streets each day (a horse produces about 20 kilos of dung per day), not to mention the 300 grams of liquid a horse releases per mile plus the thousands of dead horses that had to be disposed off each year.

The lengthening time of transport reduces man's productivity and increases the cost of doing things.

Also increasing the use of non-commercial energy via subsidies represent as redistribution of wealth from the consumers (through higher prices or through higher taxes), as well as the transfer of wealth from traditional market appointed suppliers, to the politically endowed industries.

Moreover higher prices and taxes reduces people's purchasing power.

So how does one "prosper" with such backwardness?

As you can see noble ‘romanticized’ intentions by socialists are frequently defeated by reality.

The energy dilemma should be resolved by espousing more trade freedom. Let the markets decide on which energy is more efficient, which energy meets the public’s demand for utility and which energy is the safest (one of the reason perhaps why nuclear energy flourished).

chart from Professor Mark Perry

Intervening politicians only distorts the marketplace and shifts the balance of trade towards political favourites, such as Japan’s nuclear ‘crony’ industry.

The fact is the political economic concept known as autarky, which is the root of the political call for energy independence, translates to the promotion of poverty. This also represents a form of neo-Luddism.

Who Is To Blame For High Energy Prices?

The upward pressure in the global prices of petrol products have prompted The Economists to ask “Are taxes or crude oil prices to blame for expensive petrol?”

Their narrative....

PETROL prices have risen steeply in rich countries, triggering heated arguments about whom or what is to blame. America’s energy department recently blamed a jump in petrol prices of 3.1 cents per gallon in the space of seven days on the political unrest in Egypt affecting crude oil prices. Japan’s government blamed the high price of crude oil for its tenth weekly price increase at the pump. The British government has given the same explanation for price increases averaging 15% in the year to January. But with the oil price still at only two-thirds of its peak in mid-2008, this is not the only cause—as the three charts below show

Elevated oil prices as we have repeatedly argued here, represents a mishmash of many factors that can be classified into two; mainly

-artificially high demand as a result of central banking inflationism (suppressed interest rate and QE) and

-on the supply side, the perceived shortages as a result of global governments restrictions to private investments (despite the lack of funding or technology) for political reasons, inadequate transparency of the actual state of reserves and attempts to manipulate the oil markets (OPEC cartel)—both of which has led to the escalating prices.

Lastly, taxes, which the Economist also raised, are also government imposed.

As to who is to blame for expensive petrol? I guess the answer is very much obvious: government interventionism.

The Peak Oil Myth

Here are my thoughts on Peak oil

While peak oil (via Hubbert Peak Theory) may be a valid engineering theory, it is a poor economic concept for the simple reason that engineering theories (like quant models) do not capture people’s behaviour.

Let us learn from the history of oil as narrated by investment guru Steve Leuthold

500 Years Ago… England

First let’s go back about 500 years. During the Renaissance, wood was the critical energy component in England and other European economies, much as fossil fuel is today. Wood was the primary provider of heat, light, and food preparation. However, England, having chopped down most of its trees became a large wood importer, primarily from the Scandinavian countries.

Of course prices rose as wood became more scarce causing domestic brewers, bakers, and others to go out of business hit by lower priced imports from wood rich countries. The English citizenry rebelled, having to pay exorbitant rates for wood to heat their homes, light their nights, and cook their food. Thus in 1593 and again in 1615, Parliament enacted energy conservation legislation, including limiting the use of wood in construction and mandating the use of bricks (but it took more wood to bake the bricks than to build wood structures).

From 1600 to about 1650 the price of firewood soared 80%. Then in a single year the price of wood jumped another 300%. Some families were forced to burn furniture and even parts of their houses to survive the winters. Back then, there were no government wood subsidies for freezing families.

The Wood To Coal Transition

In the early 1600s, people were aware coal was an alternative energy source. But prior to the huge rise in wood, coal was far too dirty and expensive. Chopping down trees was easier and cheaper than hacking the coal out from underground. But, as the coal industry grew, mining sophistication and technology reduced the extraction costs and as coal supplies rose prices fell.

Coal was soon found to be a far superior industrial fuel and with vast improvements in coal mining productivity the price of coal kept falling. First iron production increased with quality improving. Then came steel and steam power. The Industrial Revolution was underway led by England, which was bigger, better and earlier than old Europe. England had become the world’s industrial revolution leader. The real catalyst was the Wood Crisis.

Over 150 Years Ago… United States

Now let’s go back about 200 years to the early 1800s. Once again it’s the beginning of another hugely important energy revolution. Since Colonial times, the primary source of illumination in the U.S. had been whale oil. But by 1850 the North Atlantic had almost been whaled out by New England’s whaling fleet. The shore price of whale oil doubled and then doubled again, even though new whaling technologies had maximized oil recovery from the whales that were taken.

The high whale oil prices were also making it profitable to harpoon smaller and smaller lesser yield whales.

The U.S. was growing fast while the North Atlantic with the whale oil field yielding less and less. At the time there were, on the East Coast, no known substitutes for whale oil. By 1848 prices had skyrocketed by 600%. Then in 1848 the shortage was temporarily alleviated by the discovery (and subsequent decimation) of the South Pacific whale herds. Whale oil prices temporarily moved lower. Yes, it was a long and expensive journey for the New England whalers exploiting the new whale oil find. A whaling expedition around the horn and back could take as much as two years.

By the advent of the Civil War even this new whale oil field was played out. Low grade whale oil was $1.45 a gallon by 1865, up from 23 cents in the 1840s. To put this in to perspective, in 1868 a complete dinner in a New York restaurant cost 19 cents. A customer could buy over seven dinners for the price of a single gallon of lighting oil. It cost restaurant owners more to light the place at night than they were paying for the food they served.

The Whale Oil To Kerosene Transition

An alternative energy source became essential as high prices, population growth and shrinking supplies of whale oil combined into a crisis for businesses in east coast cities such as New York, Boston and Philadelphia. Edwin Drake set out to find that alternative. In 1858 he first found it in Titusville, Pennsylvania.

The U.S. entered the Petroleum Age. By 1867, kerosene, refined from Pennsylvania crude broke the whale oil market. By 1900 whale oil prices had fallen 70% from their highs and whale oil lamps had become collector items. Kerosene prices, with production efficiencies, became cheaper and cheaper. More importantly, just as with the development of coal as an energy alternative 200 years earlier, a chain reaction of technological and economic development was triggered. Oil soon became the new foundation of the economy not merely the low cost provider of light at night.

Lessons gleaned from the history of oil

1. People (via supply and demand) adjust to prices, where high prices leads to conservation or substitution, e.g. the wood crisis that triggered a shift to coal, whale oil crisis that led to kerosene

2. commodities obtain values only when it becomes an economic good, e.g. oil was nothing or did not have value during the age of the wood and coal or whale oil.

3. technology enhances production.

We seem to be seeing a combination of the above dynamics playout today, where alternative energies such as the production of Shale oil has been vastly expanding

To quote University of Michigan’s Professor Mark Perry (chart from Professor Perry)

New, advanced techniques for drilling oil have revolutionized the domestic oil industry in North Dakota in ways that couldn't have even been predicted just a few years ago, and will likely also open up new oil production in other parts of the world in the near future (like the Alberta Bakken in Canada) that also would have been unimaginable before this year. That's one reason that "peak oil" is peak idiocy: it always underestimates the ultimate resource - human capital (i.e. human ingenuity and the resulting innovation, advances, new technology) - which is endless and boundless, and will never peak.

Let me add that the current high prices of energy and commodities are not only from the consumption model but also from the reservation demand model—where monetary inflation influences prices.

Of course, there are other factors involved, most of which have been government imposed: geographical access restrictions, trade restrictions, price controls, subsidies, cartels, tariffs and other forms of protectionism (aside from inflationism)