| |  | | Andrew Gordon | How can the price of oil be too high? If you have an ounce of belief in the “objectivity” of free markets, you’d deem this question ridiculous. The market doesn’t have any emotional stake in either the high or low price of oil. It doesn’t care about U.S. dependency on oil. It doesn’t give a fig that high oil prices are hammering the economy. And so what if high prices are creating untold wealth in the Middle East and making Americans feel as poor as church mice. The oil market doesn’t rejoice or morn. It simply arbitrates between supply and demand. (I’m leaving the speculators out of the discussion for now. I’ve already talked about them in IDE.) But if you want to pick on oil prices, you might as well use the affordability argument. It comes straight out of our recent travails with the housing market. How did we know that housing was in a bubble? That’s easy -- when nobody can afford homes anymore. That’s not the whole story, though. Housing was in a bubble when nobody could afford to buy houses and yet houses still kept going up in price. Why? Because sellers mistakenly thought they were in control of the market. The sellers in control ... rapidly increasing supply ... soaring prices ... all added up to a bubble. At the same time, we heard claims of housing shortages ... land shortages ... prices always going up (because this time it’s different) ... and (what every bubble needs) a self-appointed lubricating machine making it all possible. I’m talking about the banks, of course. All that leveraged money chasing the last game in town – borrowers who can’t afford to borrow. When the game gets that stupid, that desperate, you know (at least in hindsight) that the end is near. So, maybe it’s about time we ask ourselves: Has the oil market gotten stupid and desperate? Does it make any sense whatsoever? On the face of it, consumer behavior is acting as expected and more-or-less rational. Driving has dropped off 2-3 percent from last year. And our oil consumption has dropped off about four percent from last year. But, with this less-than-dramatic adjustment to demand, we’re still happily or unhappily buying gas, using oil, driving and flying, and turning on our air conditioner – all in the name of comfort and convenience. In other words, high oil prices haven’t really changed the way we live. We haven’t turned into Europeans – riding our bikes to work and/or squeezing ourselves into little “Smart” cars. Nor have we turned into Taiwanese and traded our cars in for motorbikes. When it comes to oil, we’re just slightly less enthusiastic versions of our old energy-piggish selves. Again, are we being stupid or just a little stubborn? To the degree that we’re not jumping on the alternative energy bandwagon, Patricia B. would probably say we’re being stupid. But I don’t want to put words in her mouth. She makes herself perfectly clear when she says... “The emperor has no clothes and everyone knows it. Saudi Arabia can no better pull us out of this than Hugo Chavez. Peak oil is here. There have been decades of warnings. Big oil as silenced them. Our only hope is that the price supports alternatives. Viva la fuel cell, wind turbines, concentrated solar, algae biofuels and the electric car!” Patricia, we see more and more interest in alt energy. Sky-high oil prices should absolutely encourage consumers into more-reasonably priced alternatives. Coulda ... shoulda ... woulda ... but aren’t. And you know why? There aren’t any cheaper priced alternatives.
Solar is more expensive. So is wind power. At the end of the day, ethanol is too. And even at these outrageous gas prices, buying electric cars still doesn’t make economic sense – unless you plan to grow old together with your electric car. What high oil prices will do is guarantee the dominance of oil going forward. WHAT? You heard me. High oil prices will sustain the inevitable higher costs of finding and producing crude in the “peak oil” period we find ourselves in. Higher-priced oil makes the oil business very profitable. It is encouraging oil companies to produce more oil – even if it’s going to cost them an arm and a leg. The reality of “peak oil” has to make the oil companies a little manic-depressive. It describes a world in which big oil discoveries will become increasingly rare. All this money being poured into oil exploration is usually the first sign of a future bust cycle – when supply creeps up, meets and then finally exceeds demand – driving the price of oil way down. BUSTED. In a “peak oil” scenario, though, this won’t happen. All this investment into finding more oil may mean more supply coming into the market (than it would without this enormous investment), yet supply is fated to fall further and further behind demand. “Peak oil” practically guarantees the continuation of high prices (unless demand falls off a cliff). But it also means that the oil industry will be producing fewer and fewer barrels of oil to take advantage of these high prices. Peak oil is a definite mixed blessing for the oil industry. But for consumers it means high oil prices into the foreseeable future. This is obviously no bubble I’m describing. It’s a rudimentary case of supply and demand. Consumers are slowly ratcheting down demand, but in the absence of immediate alternatives to oil, that trend only has so much play. Producers are pouring money into increasing supply, but in a period of “peak oil,” this actually makes much more sense now than in previous periods when supply was lagging and prices were soaring. Very rational behavior all the way around. Seems like nobody gets the stupid tag, yes? Well, at least one reader disagrees. And, as with housing, there’s one lubricating machine making it all possible. But it’s not the banks. It’s the government. Jonathan gives us his take... “I'm really tired of hearing the US press whining about how foreign subsidies are propping up demand for oil in foreign countries... Your government is using your tax dollars to indirectly subsidize your fuel cost. "Non-oil industries are taxed at a rate of 18 percent, the oil industry is taxed at a mere 11 percent. This reduced rate equates to $2 billion in federal corporate income tax benefits per year. They also benefit from low state and local sales tax rates on gasoline, an indirect subsidy exceeding $4 billion a year. Direct government funding of oil and motor vehicle infrastructure and services tops off at $45 billion a year. Pull the wool off your eyes. It's not your oil, you buy it from people who don't particularly like you. Oil has been marketed like cocaine and you have an addiction, are you really surprised the dealer has upped the price? Your government and your financial institutions are just as complicit in mucking with the markets and subsidizing the cost and you still end up with the bill.” Jonathan, even if only half your numbers are more-or-less accurate, you’ve still made a powerful argument. I’m just not sure if I should half-believe you. For one, I don’t know where the 18-percent tax rate for non-oil industries comes from. And a lower sales tax as an indirect subsidy? Perhaps – if prices could be raised by the amount that the sales tax is lowered. But it usually doesn’t work that way. Then there’s your statement about the $45 billion infrastructure spending. Yes it helps the oil industry. But it helps the auto industry just as much. Plus it also helps any kind of commerce that depends on vehicular travel – trucking, busing, and when you think of it, the very existence of the suburbs. But as I said, if just part of what you say is true, we can’t afford nearly as much oil as we use and our tax dollars are being badly misspent (though that hardly qualifies as news). I’ll leave it to another reader to have the last word. He also makes a connection between the housing market and the oil market but in a different way than I have... “I think oil prices are much more related to the devalued dollar than limited supply...
Why don't we tell it like it is: we have allowed the wrong people to run our country and the world. They have debased our money... “Real wages have gone down considerably in the last 8 years. This was done by creating an artificial bubble in real estate so people could borrow against the artificial increases in the value of their homes. The whole bubble was created by artificially created low interest rates.
They were dumb, happy little homeowners living on increasing debt and stagnate wages during a period of inflation. Now that the bubble has broken these homeowners are struggling to live on wages alone and those wages have gone down in purchasing value by 20 to 40 percent due to 8 years of inflation. A recipe for total disaster...” Might I add that those same diminished wages are now finding it difficult to pay for the price of gas. It does make for a neat little package, doesn’t it? Invest well, Andrew Gordon P.S. To let me know what you thought of today's article, send an e-mail to: feedback@investorsdailyedge.com. | 
