Gasoline Prices and the Macaca Plan

Senator George Allen tries to link energy policy with the war on terrorism offering this plan:

Mr. President, I strongly believe that a comprehensive, enduring, sustained, and strategic plan for independence from the Middle East and other hostile sources of foreign oil must include 5 essential elements:

1st, the strategic use of our global economic power and international relationships to remove the oil-based leverage that hostile states now enjoy.

2nd, the accelerated exploration and development of American energy supplies – including American oil, American natural gas, American clean coal, and American nuclear power.

3rd, the accelerated research, development, and deployment of every economically viable alternative and renewable source of energy.

4th, a bold new national commitment to innovation and entrepreneurship, investing in the next generation of leading-edge, creative scientists, researchers, and engineers of advanced technology.

And, 5th, an unequivocal declaration of our national security commitment to energy independence.

Cesar Conda is loving it:

Now that prices are going down, the GOP can stop being on defense when it comes to energy policy, and start going on offense – by talking about the need for a credible, long-term strategic plan for energy independence. In other words, the changing energy market has changed the political market as well, and in a way that helps Republicans if they proceed correctly.

We’ll likely hear a lot of GOP gloating over this recent drop in gasoline prices in the run-up to the 2006 elections even though – as James Hamilton notes – one could have predicted this decline:

Although crude oil prices can be quite hard to predict, retail gasoline prices are at times a little easier, because it often takes some time for price declines in crude oil or bulk gasoline to work their way down to the retail level. A useful advance indicator of where retail prices are headed is the NYMEX gasoline futures contract, which yesterday traded down to $1.55. This futures price does not include taxes or the wholesale and retail markup, which in recent years have averaged about 60 cents a gallon. Using that 60 cents benchmark, a retail gasoline price below $2.20 a gallon appears to be quite reasonable to anticipate. So why are gasoline prices coming down so dramatically? There are important seasonal factors in U.S. gasoline prices, which are higher in the summer due to summer fuel requirements and greater gasoline demand. Everyone always seems as shocked when prices go up in the spring as when they come down in the fall, even though to some extent that same pattern is repeated every year. However, much more than just the usual seasonal is in operation this fall. The drop in crude oil prices, down $14/barrel over the last month, has now become the dominating factor. Some might be tempted to attribute part of the recent decline in crude oil prices to last week’s widely publicized ultra-deepwater production tests from the Gulf of Mexico. However, it seems pretty unlikely that this has made a material contribution to crude oil prices.

Dr. Hamilton provides a graph of retail gasoline prices over the past 3 months. Our diagram traces this price back to 1994 and was constructed using data from this source. Notice that we saw $3 a gallon gasoline right after Katrina, which was followed by a similar decline. Gasoline prices are not low – they have been volatile. Some of the recent volatility has been due to swings in the refinery margin but much of it has to do with changes in oil prices. This source shows how oil prices spiked up to $77 a barrel because the most recent decline. It also provides a graph of oil prices in real terms (2004$) from 1869 to 2004. Real oil prices fell from $70 a barrel in 1869 to an average prices less than $20 with the price being $62 a barrel during the late 1970’s and early 1980’s, which has been attributed to the Iran/Iraq War. The recent Middle East mess was part of the reason why real oil prices reached $72.50 (yes, a historical record even in inflation-adjusted terms). The recent decline in oil and gasoline prices is neither a surprise nor attributable to government policies of this Administration.

But let’s turn to what Senator Allen is suggesting. Is his first proposal suggesting we build a strategic reserve and use it to smooth the volatility in oil prices? I suspect Al Gore will like this idea – even if George W. Bush hammered the Vice President in 2000 when he made a similar suggestion. His other proposal seems to be the use of government subsidies to encourage development of alternative energy sources. Democrats might be saying – welcome to the club.

But why does Mr. Conda think this dip in prices enhances the chances for more conservation and greater use of energy sources? Lower prices tend to increase quantity demand and reduce quantity supplied. Conda seems to be making a political argument as he hammers Democrats for making similar arguments. Democrats who advocate government subsidies to lower gasoline prices should be hammered. This Democrat, however, is hoping that high oil prices and market forces will work in the long-run to encourage sources of energy supply as they encourage conservation. On this score, I see very little attractive in this Macaca proposal.