2009 US Petroleum Trends

The American Petroleum Institute (API) released its annual oil statistics for 2009 to the press yesterday afternoon, and I participated in their media teleconference this morning covering the results. The numbers reveal some interesting shifts, and they provide another useful barometer on the state of the US economy, for which oil is still the largest energy input by a wide margin. Total petroleum and refined products deliveries, reflecting aggregate demand, continued their downward trend last year, averaging 4% below 2008 levels, but interestingly were only down 1.8% in the fourth quarter, compared to 4Q08, with December actually showing a slight uptick vs. December '08. Here are a few of the underlying details that caught my eye, and my reactions to them:

• Gasoline bucked the overall downward trend in product demand. Despite prices that recovered steadily throughout the year from their late-2008 lows and surpassed their year-earlier levels in the fourth quarter, gasoline demand posted a 0.3% increase vs. 2008, with 4Q09 showing a 1.1% rise compared to 4Q08 and an even stronger finish in December. This is entirely consistent with the observed reversal of the decline in vehicle miles traveled, which still dominates improvements in fuel economy, despite the Cash for Clunkers uplift.
• In contrast, diesel demand remains very weak, with the low-sulfur and ultra-low-sulfur diesel deliveries that correlate with goods shipments and overall economic activity running at 7.5% below 2008, with little or no improvement in 4Q09. (Are the results of recent gains in economic activity mainly replenishing depleted inventories?)
• US refineries operated at less than 83% of their nameplate capacity for the year and fell below 80% in December. The poor margins this creates are buffeting oil company earnings but buffering consumers from the full impact of recent increases in oil prices. If utilization stays at such low levels, a major shakeout in refining could be coming, beyond the refinery closures we've already seen. This will be exacerbated by the completion of major refinery expansions on the Gulf Coast, including Marathon's Garyville, LA refinery project starting up now and the more-than-doubling of the former Texaco Port Arthur refinery, now owned by a joint venture of Shell and Saudi Refining, due within a few years.
• US imports of crude oil and petroleum products fell by over 9%, with products taking the biggest hit, proportionally, falling by half a million barrels per day. This is good news and bad news, since much of it is the result of the weaker economy.
• Happily, roughly a third of the drop in imports was attributable to higher US production of crude oil and the liquids accompanying higher natural gas output--a byproduct of the shale gas boom. As API's Chief Economist John Felmy pointed out in the call, that was partly the result of a year without major hurricanes in the Gulf of Mexico. However, it also validates the time lags involved in bringing on new production triggered by the spike in oil prices that began in 2003-4.
• The mix of our foreign oil suppliers is also shifting, with lower imports from Mexico--production there is collapsing--and Venezuela, two of the mainstays of our supplies over the last several decades. Despite this, imports from the Persian Gulf made up just 17.5% of the total through October, compared to 22.5% from Canada. And although they didn't make the top 10 list this year, imports from Brazil are coming on strong. This is a testament to that country's policies for developing its vast new resources. Look for Brazil to enter the top 10 list this year, as Mexican output continues to drop and Brazil surges.

I'm sure I missed some other nuances, and I regret not being able to provide links to the original figures, since access to the data requires a subscription. I'm sure I'll be commenting on many of these trends at greater length and referring to public data from the Energy Information Agency of the Department of Energy, as they become available.

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Oil Prices and the Recovery

As oil prices continue their upward trend, I'm noticing more articles and getting more comments from readers questioning whether $80-plus oil could squelch the nascent economic recovery--or for those who believe the recession isn't over, deepen it again. It's not an unreasonable question, particularly when we compare current retail fuel prices to their level of a year ago: the "gasoline stimulus" that I was tracking for much of last year. A quick glance at the chart below reveals that instead of paying a dollar or more per gallon less than twelve months earlier, as we were for much of 2009, the average US retail price for unleaded regular is now roughly a buck higher than it was the same time last year. That can't be favorable news for consumers or for businesses depending on a resurgence in consumer demand for other goods and services. But is it enough to stall economic growth?


Although I still check oil prices on a regular basis--at least every couple of days, instead of every few minutes when I was trading the stuff--sometimes I notice price trends the same way most of my readers do: by driving by neighborhood gas stations and watching the most visible price in America change day to day. The recent steady, counter-seasonal rise against the backdrop of generally slack demand and comfortably high inventories, and in the absence of any significant global supply disruptions has had me a bit perplexed. And it's really all down to oil prices, since refining margins remain fairly weak and are only as strong as they are as a result of several refineries being shut down entirely and most others running at historically low rates of throughput.

Nor does this seem to be an instance of what I've called the oil-dollar price loop. Since December 11, 2009 crude prices are up by 18%, despite the US dollar strengthening by 3% against the Euro and 5% against the Japanese Yen over the same interval, amid a general surge of commodity prices.

Most analysts seem to attribute higher oil and commodity prices to higher demand from countries like China, as the global economy responds to the impact of various stimulus packages and the stabilization of the banking system. China's growth has been particularly impressive, but even if this is boosting its demand for oil imports by 25%, as one source suggested, that hardly seems likely to swamp the substantial spare capacity that OPEC has accumulated in the last year and a half. As I noted last week, OPEC has successfully held over 3 million barrels per day off the market and maintained global oil prices at a level that wouldn't be possible based only on renewed economic growth in China and its anticipation by the market elsewhere. OPEC has attracted remarkably little flak for this policy, which a year ago probably prevented oil prices from going into free fall. That would have harmed all producers, and eventually consumers, too, by drying up future supplies.

So what's the financial impact of OPEC's self-restraint on US consumers and our economy? Even if you ignore the year-earlier comparison, current retail gas prices are around 30 cents per gallon above their average for last year. For a household driving 25,000 miles per year in typical cars, that's worth at least $25 per month. Across the entire 138 billion gallon-per-year gasoline market, that aggregates to around $40 billion/year. Applying the underlying $13/bbl oil price rise since mid-December to our net oil imports of roughly 10 million bbl/day, that figure increases to just under $50 billion/year.

As unwelcome as this additional drag on the recovery might be, at current levels it seems unlikely to further derail our $14 trillion economy, even if it contributes several billion dollars a month to our trade deficit and, along with high unemployment, depresses consumer confidence. However, near-$3 gas is one thing; widespread expectations of a return to $4 per gallon would be quite another. While higher oil prices mainly due to OPEC restraint aren't yet a cause for panic, this trend certainly bears watching.

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Is Oil Shock 2.5 Imminent?

The rebound of oil prices has been getting a good deal of attention, lately, though we haven't yet reached the point at which, like much of last year, the daily closing price of WTI is reported on every evening news broadcast. I've even seen the dreaded "s-word" bandied about, implying that oil might have become disconnected from its fundamentals in ways that ought to worry those responsible for ensuring that the nascent economic recovery is not extinguished before it can gather momentum. Such fears look premature at this stage. Despite reaching $70 per barrel during last Friday's session--an increase of 107% from its post-crash lows last December--crude remains far below its highs of 2008 and currently trades at a level it first reached in spring 2006. Nor does it seem likely that US demand would support a return to $4 gasoline, which helped alter consumer behavior in ways that set the stage for oil's precipitous collapse and could do so again.

To understand current pricing, we have to pull apart the threads affecting supply and demand. On the supply side, the dampening effect of high oil inventories is offset by worries that high decline rates from mature fields and deferred and canceled production projects are setting the stage for a repeat of the capacity crunch of 2004-7 as soon as global demand growth resumes. Last week's Economist did a fine job explaining how each oil bust contains the seeds of the next boom, and why that cycle could be even shorter this time around. And in a recent "Heard on the Street" column, the Wall Street Journal's Liam Denning provided some insightful analysis on how traders playing the spread between short- and long-dated oil futures can translate higher prices for the out-year contracts into a boost for near-term prices. (He also questions the sustainability of China's recent oil import spike.) But if current oil prices are being dragged up by concerns about future supply--abetted by inflation fears and the recent weakness of the dollar--weak demand and its demonstrated elasticity should forestall an imminent return to last year's peak.

In recent weeks US gasoline demand has rebounded close to last spring's level. Driving season still matters, it seems, and we've seen pump prices respond accordingly. This reflects more than just the recent strength in crude oil. The NYMEX "gas crack", the spread between prompt gasoline and crude oil futures, averaged $2/bbl higher in April and May than in February and March, at the same time crude oil added $30/bbl. However, this strength is merely relative. US gasoline demand in the first quarter of 2009 was the lowest for that period since 2003, and that's before taking into account the approximately 175,000 bbl/day of demand--around 2%--met by higher mandated ethanol blending, after adjusting for energy content. Moreover, demand for distillate fuels--diesel and heating oil--is off even more than for gasoline. This isn't just a US phenomenon, either. The International Energy Agency sees global oil demand down by 2.6 million bbl/day, or 3%, vs. last year. That's no one's idea of a surge.

When we sum up all these developments, we see a very different dynamic than the one that took oil prices to the brink of $150/bbl. Then, demand seemed insatiable, and the capacity crunch was a measurable reality, not just a future prospect. Today, oil supply and demand and the global economy are linked in a set of counter-acting feedback loops. Higher petroleum product prices put greater pressure on price-sensitive consumers, whose ranks have been swelled by the recession. Even countries that insulate their consumers from the global oil market may have to adjust if prices edge closer to $100/bbl. So while higher oil prices could threaten economic growth, the demand response to higher prices--and any hesitation in expected growth--seem just as likely to stall oil's momentum and send it lower. This is a delicate balance, and it could be upset by many factors, including a sudden change in the value of a key currency, or an unanticipated supply disruption. Only time will tell whether, just as Oil Shock 1.0 (the Arab Oil Embargo) was followed a few years later by Oil Shock 1.5 (the Iranian Revolution), last year's Oil Shock 2.0 will soon be followed by version 2.5, or give way to entirely new scenario.

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Fuel of the Past?

Today's Wall St. Journal features a front-page article sounding the death-knell for the growth of US gasoline demand. The combination of recession, stricter fuel economy standards, and the hangover from last year's high gas prices, together with growing biofuels consumption, appears to herald a peak in gasoline sales. The Journal cites a forecast from ExxonMobil in support of its conclusions. However, to assess the full implications of such a shift, it's important to differentiate between a decline in the requirement for the petroleum-based components that gave gasoline its name and the demand for the fuel generically referred to as "gasoline", which in most of the country already includes up to 10% ethanol, and is likely to include a more diverse mix of non-oil constituents in the future.

According to data from the Energy Information Agency of the DOE, US average daily gasoline consumption peaked in 2007 at 9.29 million barrels per day (MBD), declining by 3.5% last year. However, if we back out the blended ethanol volumes included in that tally, petroleum-based gasoline demand peaked a year earlier at 8.93 MBD and has fallen by 5.3% since then. With a federal renewable fuel standard (RFS) that mandates ever-higher volumes of biofuels, and with the apparent breakdown of many of the trends that have been driving gasoline consumption up since the end of the energy crisis of the 1970s and early 1980s, including annual vehicle miles traveled, that 2006 figure could prove to be the high-water mark for petroleum gasoline. However, the Journal's analysis also ignored or downplayed several factors that could soften its decline, particularly for the oil-and-biofuel blend that "gasoline" has become.

The most obvious of these is low fuel prices. Since monthly gasoline demand bottomed out at around 8.5 MBD last August, we've seen demand rebound somewhat, in response to the dramatic drop in gasoline pump prices. But while this factor might be self-correcting, since higher demand will tend to push up prices, which will retard further demand growth, another factor is creating a new source of steady underlying demand growth: As the RFS ratchets higher, the energy content of gasoline falls, and it takes more gallons to travel the same distance. With 8 billion gallons of ethanol included in last year's gasoline sales, the average gallon of gas delivered 112,700 BTUs to your car in 2008. At the 13.2 billion gallons of ethanol required in 2012, that figure would fall by 1.2%, requiring a corresponding increase in volume to compensate for its lower energy content. In fact, unless sales of biodiesel ramp up significantly, relieving the pressure to blend more and more ethanol into gasoline to satisfy the RFS, the current car fleet would require 7% more of 2022's "gasoline" to drive the same total miles as last year.

Under the federal fuel economy regulations enacted in 2007, the increased demand for less-energetic fuel should eventually be overwhelmed by the energy-efficient cars expected to make up a sizable fraction of the US car fleet by 2022. If anything, those standards will become even stricter, as the administration seeks to align fuel-economy rules with California's pending tailpipe standard for greenhouse gas emissions. As with everything else, though, there's no free lunch for CAFE standards. The same weak economy that is constraining gasoline demand is depressing car sales to an even larger extent. I haven't seen any credible forecast suggesting those sales will bounce back to their pre-2008 level of roughly 16-17 million vehicles per year any time soon. At 12 million cars per year, which would represent a nice rebound from today's levels, it would take an extra 5 years to turn over the existing US fleet of 245 million light-duty vehicles (ignoring motorcycles.) That assumes no net growth in the fleet, despite US population growth of roughly 1% per year. It also remains to be seen whether fuel prices and/or tax policy will effectively nudge Americans into the more efficient cars that the government wants us to drive.

On balance I think the Journal is right to conclude that the heyday of US gasoline has passed. However, much as with Peak Oil, anyone expecting a prompt and precipitous sustained drop in US gasoline demand is likely to be disappointed by the structural inertia of an enormous, slowly-changing vehicle fleet, a growing population, and alternative fuel regulations that are steadily diluting the energy content of the fuel. That means that while oil companies can't count on gasoline sales growth here to drive future profits, the mature US gasoline sector could still serve as a cash cow for their other business lines, including the search for more oil to meet the growing energy needs of large developing countries. Every first-time car buyer in China and India adds another increment of net global demand, and the industry will have its hands full satisfying that demand, once the global economy gets back on track.

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Demand Rebound

For a long time, it appeared as though US gasoline consumption was impervious to increasing prices. Last year we learned again that the price elasticity of gasoline demand, while low, is not zero, as the combination of $4 prices and a weakening economy triggered a change in America's driving habits, turning the vehicle miles traveled and fuel use trends negative for the first time in years. However, price elasticity works in both directions. Gas prices are now not only lower than their average for all of 2008; despite recent increases this week's average pump price of $1.96 per gallon remains cheaper than the same-month comparisons for 2006 and 2007, as well. This was bound to have an effect on demand, and the API statistics for January reflect the first year-on-year increase in monthly gasoline consumption since 2007. Even if this reversal is ultimately overwhelmed by the contraction of the economy, it provides one piece of evidence that structural demand might not have changed as much as some might like to believe. That has implications for future oil demand and prices, once the hoped-for economic recovery begins, and for what consumers should be factoring into their decisions.

Other than for gasoline, the API stats contained few surprises. Total petroleum product demand was down 3.1% from last January, on the back of big declines in diesel, heating oil, and jet fuel consumption--sure signs of the weakness of the economy. US oil production ticked up slightly, reflecting the lagged benefits of all the investment that has gone into the sector since prices started rising. Nor should the gasoline figures have startled anyone, since the Department of Energy's weekly estimates have been pointing in this direction for some time, as noted recently in the excellent R-Squared Energy Blog. Surprising or not, January's demand blip should put an end to wishful thinking about permanently altered lifestyles and consumption patterns.

What does this mean for government policy and for consumers? It points to a return to higher oil prices within a relatively short time after the economy resumes growing, and everything that goes with them, including high gas prices that will strain household budgets, just as they would be getting back into balance, and a bigger oil-import bill for the country, putting pressure on the trade deficit, the dollar, and our ability to finance the vast debt we are accumulating to combat the recession and financial crisis. Nor can we rely on big improvements in vehicle fuel economy to keep demand low. New cars built to meet higher corporate average fuel economy standards will feed into our fleet of 245 million cars and light trucks slowly, at best, particularly if Chrysler's pessimistic forecast of sales at the 10 million car/year level for the next four years proves correct.

That doesn't mean we should wait passively for the next oil price spike. If we want to keep oil imports as low as they are now, we'll need to produce more of it ourselves, because until there are millions of plug-in cars on the road, all those renewable energy projects that the stimulus bill should help advance will have no effect on our oil use. That means offshore drilling, like it or not. On a personal level, if you're buying a car, factor in the likelihood that gas won't remain at $2/gal. for more than a year or two. If you're taking advantage of the slump in housing prices to buy a home, minimize its distance from your workplace, rather than trading more miles for more square feet, as many Americans did for the last decade--and remember that every extra square foot will cost more to heat and cool in the future, too. In short, enjoy the near-term benefit of today's low prices, but act on the assumption they will go back up, again.

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A Painful Adjustment

A quick read through the morning paper reminded me just how much the future path of energy prices and energy sector investment depend on the economy, and on the measures intended to speed its recovery. It doesn't seem like so long ago that the situation was exactly reversed, with the economy faltering in part due to a massive oil price shock. Now, the very things that energy strategists and planners most took for granted--the steady pace of demand growth driven by an expanding global economy and unimpeded access to financing for projects large and small--have become the biggest uncertainties affecting the industry. A random selection of articles and op-eds in today's Wall Street Journal seems to confirm that these uncertainties won't be resolved quickly. Indeed, they cannot be, until the recession has done its unpleasant work of re-directing employment and investment away from sectors that grew unsustainably large during the parallel housing and consumer debt bubbles, and towards new and better uses.

In the Money & Investing section we read, "Oil Rallies on Stimulus Hopes." With the volatile expiration of the February crude oil contract behind us, March West Texas Intermediate settled at $43.67 yesterday. But the rally in question, of four days duration, doesn't change the fact that this same March contract has declined by about 70% since its high last July, and by 10% since last December 31. No one expects a return to last year's peaks, but the hopes for a quick agreement on an economic stimulus package ought to be tempered by the enormity of the task that package is intended to accomplish, and by our questionable ability to sustain the requisite deficits long enough to see its programs through.

The challenge is illustrated by an article that provides the kind of good news/bad news mix typical of a deep recession: "Home Construction at Record Slow Pace." At December's seasonally-adjusted annual rate of 550,000 units, new home construction is apparently at the lowest level since at least 1959, and half its rate of a year earlier. This is clearly bad news for anyone working in home construction and all the businesses that supply it. However, it's good news for current homeowners, since less supply will eventually lead to higher prices. It also reflects the reality that the home construction sector cannot be maintained at the scale it reached during the housing bubble. Too many of the country's resources were devoted to building new and bigger homes, fueled by unrealistically high levels of debt. Finding more productive and sustainable employment for the people and businesses affected is just one task of the stimulus, and of the recession itself. The same is true for a consumer-goods sector, including retail, that also grew unsustainably large, driven by massive home-equity and credit card debt.

For all the hopes pinned on the stimulus, its Achilles heel is the scale of the deficits involved, on top of a preexisting budget deficit and the enormous loans made to the banking sector. While the projected US deficits in 2009 and 2010 might look manageable as a share of GDP, their absolute magnitude raises serious, unanswered questions about funding. "The World Won't Buy Unlimited U.S. Debt," points out one op-ed in the Opinion section. I understand the risks of doing too little and the worries about a liquidity trap, in which monetary policy loses its effectiveness, or entering a deflationary spiral; however, the stimulus carries risks of its own. Nor can we forget that ours is not the only government taking on more debt to fund an urgent stimulus. "Expect the World Economy to Suffer Through 2009," conclude Ian Bremmer and Nouriel Roubini, of the Eurasia Group and NYU, respectively.

We need to keep all of this in mind, as we assess the stimulus package that the Congress and new administration are designing. Every assertion that it should be as big as possible should be balanced by a reminder that, because we will go deep into debt to fund it--with unpredictable consequences--it should not be one dollar larger than truly necessary. In particular, that means that provisions that can't be shown to have a high likelihood of putting people and businesses to work productively in the next 18 months should be deferred until we have a clearer sense of the receptiveness of global lenders for the mountain of Treasury bonds and T-bills the government must issue to pay for them. I'm glad I don't have to make those choices, and I wish our elected leaders the greatest success in this endeavor. Much more than just energy markets hinges on it.

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When Is Cheaper Oil Bad?

Talk about a reversal of fortunes. A mere two months since oil was flirting with $150 per barrel, OPEC is considering production cuts to defend a $100 price floor and reputable journals are suggesting that $80 could soon be in sight. Whether this is interpreted as the popping of a speculative commodities bubble or the market's rational response to slowing demand from a weakening global economy, cheaper oil would present policy makers with a dilemma. In particular, it could force some of them to consider unpopular steps to rein in demand, since the market may stop doing that for them.

Cheap is in the eye of the beholder. Not many years ago, forecasts of $80/bbl oil seemed unrealistically high, and $100 belonged in the realm of fantasy. The inflation-adjusted high from the last energy crisis equates to around $94/bbl in 2008 dollars, so until oil finally crossed the $100 mark, we could comfort ourselves with comparisons suggesting that our problems hadn't yet attained the same scale as in the 1970s and '80s. When crude oil approached $120 in April, the average US gasoline pump price hit $3.50/gallon, and US demand began to drop with a vengeance, compared to the prior year. The shock waves from $4 gasoline in June and July are still reverberating. Yet if crude continued its slide and ended up near $80, and refining margins remained as weak as they have been, we would shortly see pump prices beginning with a "2", again.

The benefits for the US economy would be substantial. At $80/bbl, our national oil import bill would be more than $150 billion per year lower than with $120 oil. Gasoline at $2.75/gal., instead of $3.75, represents a $140 billion boost for consumers, larger than the proposed second stimulus package. Lower prices, however, would also inevitably lead to higher demand. That might begin to strengthen oil prices again, creating something of a roller-coaster effect. More importantly for those concerned about climate change, it might reduce the urgency of the switch to more fuel-efficient vehicles, putting a greater burden on other planned policies to manage US greenhouse gas emissions.

Some of the other implications of a respite from high oil prices look helpful and less politically stressful. US carmakers need a couple of years to retool to produce more efficient cars here, similar to the ones they already make in Europe. As long as the oil-price decline was broadly viewed as temporary, resulting from factors likely to reverse again, once the global economy resumed strong growth, they wouldn't be tempted to ease up on their efforts. And they must still meet a 35 mile-per-gallon fleet-average fuel economy standard within a few years. The same logic would probably hold for airlines that need time--and profits--to bring more fuel-efficient planes into their fleets and reconfigure their route systems.

Nor would lower oil prices necessarily be bad for the alternative energy sector. Ethanol makers are expanding production to fill a federal mandate, and their sales to refiners and gasoline blenders wouldn't be hurt much if ethanol reverted to costing more than wholesale unleaded gasoline. And renewable electricity technologies such as wind or solar power should be largely unaffected, since their output doesn't compete with oil, and their funding doesn't derive from it--yet.

On balance, then, the negatives of falling oil prices might be felt most severely by two groups with as little in common as one could possibly imagine: oil companies and politicians. As long as oil prices were going up, Senators, Representatives and presidential candidates could support measures to reduce greenhouse gas emissions, while simultaneously arguing that fuel prices were too high. Now, if oil prices keep dropping, the disconnect between lower fuel prices and lower emissions will become more evident. Environmental groups would push harder for Congress to enact measures to control CO2, such as cap & trade or a carbon tax, either of which would translate into higher prices at the gas pump. That would confront our leaders with the stark choice between publicly supporting steps that would certainly raise gasoline prices, or setting aside concerns about climate change in the interests of helping a weak US economy. I take no delight in that prospect.

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The Persistence of Change

Weakening demand appears to be the main oil market driver these days, with the US having just tallied its 12th consecutive monthly decline in gasoline demand, year-on-year. For the moment, at least, good old supply and demand have displaced imminent Peak Oil and a perceived commodity bubble as the dominant narrative. If we needed further evidence of that, the market's collective yawn at Russia's threat to the Caspian pipelines passing through Georgia ought to serve nicely. But how much of the recent decline in consumption is attributable to the price elasticity of demand, and how much to the weakening US economy? The answer is of more than passing interest, signifying whether we're likely to see a bounce in demand once the pump price catches up with the 20% decline in the price of West Texas Intermediate crude oil since the 4th of July.

The US average retail gasoline price has fallen for six weeks and currently stands at $3.74 per gallon. Barring an unexpected oil-price rally or a major refining problem, unleaded regular prices beginning with a "4" should soon disappear at all but the most expensive stations, even in California. Perhaps this is just a case of the August doldrums, but the price of oil is currently stuck in a range that defies the principal explanations for its behavior earlier this year. With the market clearly responding to fundamentals, its path from here will depend heavily on whether consumers continue to drive less, and that depends on the relative importance of the psychological impact of $4 gasoline, compared to a broad range of economic factors including falling home prices, tightening credit and surging inflation--some of which is attributable to high fuel prices.

The last stretch in which US gasoline demand declined for 12 consecutive months occurred in 1990-91, a period that also coincided with a spike in fuel prices--thanks to Saddam Hussein--and a recession. The Gulf Coast hurricanes of 2005, which gave the country its first taste of $3 gasoline, caused only a brief drop in demand. Within 3 months of Katrina's landfall monthly US gasoline demand had resumed its year-on-year growth, consistent with the robust economic growth (helped by the housing bubble) that we were experiencing at the time. Nor did the recession of 2000-2001 prevent gasoline demand from growing by 1.6%, with only a few months exhibiting declines versus the same month of the previous year. Of course, gasoline was well under $2 at the time.

It seems to require an unusual combination of low growth and high prices to overcome the inherent gasoline demand trend of the US economy and shock consumers into conservation mode. Since the economy seems unlikely to recover soon, the persistence of the recent changes in consumer behavior concerning fuel consumption and new car selection thus hinges on just how cheap $3.50 gas will seem to America's drivers after a couple of months over $4.00 per gallon. In the absence of more dramatic events, this could also determine the price of oil on Election Day, a parameter that could influence that contest's outcome.

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Leveraging the SPR

Election-year politics and prudent energy policy do not mix well. The combination is even worse when the election cycle coincides with a genuine energy crisis, and both parties seek to curry favor through short-sighted proposals aimed at producing votes, rather than BTUs or kilowatt-hours. We saw this earlier in the year with suggestions by Senator Clinton and Senator McCain to suspend the federal tax on motor fuels for the summer, and we are seeing it again in calls by the Speaker of the House and others to release oil from the Strategic Petroleum Reserve to drive down fuel prices.

It's remarkable how quickly the debate over the Strategic Petroleum Reserve (SPR) has shifted from halting additions to it, to draining it. The former was eminently sensible, in light of the cost of the program and the possibility that diverting small quantities of light, sweet crude into storage was having a disproportionate impact on the price of all oil. The balance of risks strongly favored suspending additions to the SPR; quite the contrary is true for using SPR oil to create a brief, convenient slump in the oil market, while diverting attention from the more serious discussion of increasing supply and reducing demand--both sides of which would be harmed by a non-emergency release from the SPR.

Make no mistake: the current SPR is a relic of the energy crisis of the 1970s that merits serious re-thinking about its fundamental purpose and the best way to achieve it in a very different economic and geopolitical environment. It is also possible to conceive of ways in which oil in the SPR could be used to speed up the contribution of production from new oil fields, once they are identified and under development, via SPR vs. reservoir exchanges. However, such considerations are quite different from simply dumping SPR oil into the market--volumes that under the policy passed by this Congress could not be replaced as long as oil remains expensive--for no purpose other than to provide some relief at the gas pump, where prices are already likely to fall by another 25-35 cents per gallon, based on the past week's drop in the crude oil and gasoline futures markets.

The problems with releasing SPR oil now are straightforward. Inventory is not production. The proposed draw-down is not sustainable, while the production that new drilling could add would contribute to our energy supplies for a generation. Moreover, oil prices are a classic stock-and-flow system, reflecting the current balance between actual supply and actual demand, and the difference between actual inventory and desired inventory. Although the flow of SPR oil into the market would create a temporary glut and drive down the price of oil for prompt delivery, the subsequent lower inventory levels--even for an emergency back-up such as the SPR--could result in even higher prices after the release program ended than before it began. At the same time, this signal--not just from lower current prices but also from the demonstrated willingness of the government to use the SPR to manipulate the market--would deter new energy projects, including those for alternative fuels that are more attractive when oil prices are high, while impeding our transition to more efficient vehicles.

The world has changed in many ways since the SPR was first opened, and some of those changes make it even more essential for the US to have quick access to large volumes of oil in extremis. Among other things, our net oil imports have doubled since President Ford signed the SPR into law in 1975. Although oil prices remain high, supply still meets demand. Yet it is far too easy to envision plausible scenarios in which that would not be the case, involving terrorism, expanded conflict in the Middle East, or the effects of Peak Oil. In any of those cases, we might find that the SPR's current 160 days of supply at its 4.4 million barrel per day maximum delivery rate are not nearly as ample as they seem.

Aside from expediency, the theory behind releasing SPR oil now is based on a flawed narrative involving a bubble in oil prices. If the evidence were clear that supply and demand would balance at a much lower oil price, and that speculators were responsible for a large fraction of the current oil price, then I could support using a brief release from the SPR to crush speculation. The reality appears much different. Oil prices have fallen since this debate started, largely because of the extraordinary reduction in demand that high prices and a weak economy have triggered--and not because the market sees a realistic prospect of a SPR release this year. Oil is trading today below $125 per barrel for delivery in September 2008, as well as for delivery in December of 2010, 2011 and 2012. That could change tomorrow, due to some event, but it suggests that the impact of speculation is more like the foam in a glass of beer than a steadily-inflating bubble. The interests of the nation would be better served by a Congressional commission on re-engineering the SPR for the 21st century, than by Congressional legislation to fritter away this $88 billion asset in the pursuit of short-term goals.

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Driving Less

The signs that Americans are driving less are everywhere. From headlines such as, "Gas Prices Spur Drivers to Cut Use to Five-Year Low", to increasing ridership on mass-transit systems and TV news segments on the growing numbers of folks bicycling to work, we see $4 gasoline doing what $3 fuel didn't: deliver a meaningful conservation response. But before we pat ourselves on the back for the DOE report that gasoline demand has fallen by 3% compared to last year, we should review a somewhat longer stretch of our recent history of fuel consumption and vehicle miles traveled. It suggests that the current decline, abetted by a weak economy, barely scratches the surface of our per-capita fuel consumption increase since 1995.

Conventional wisdom blames the SUV fad for most of the increase in US oil consumption in the last decade or so. But while rising sales of large SUVs in that period certainly helped to stall the positive trend of passenger car fuel economy, the bigger culprit has been the heretofore steady growth in vehicle miles traveled (VMT.) Between 1995 and 2005 this statistic grew by 23%, slightly more than the 21% increase in gasoline and diesel fuel consumption, and ahead of the 19% expansion of our car and light truck fleet. By comparison, during this period the US population grew by about 13%. In other words, Americans have been driving more cars, and on average driving them farther each year, than in 1995, accounting for more of the accompanying increase in fuel consumption than SUVs. This year's 2% decline in VMT compared to last year's record figure only erases part of the roughly 10% per capita growth of average annual miles driven since 1995. If we unraveled the rest of that growth, we could reduce US gasoline consumption by another 8% without any contribution from the higher fuel economy of the new cars consumers are now choosing. That equates to more than twice as much oil as our use of ethanol will save this year.

I don't pretend that conservation on that scale would be easy or costless. Some portion of the increase in VMT is structural, in the form of workers traveling longer distances from communities beyond the traditional suburbs. Much of the rest is associated with some sort of economic activity, including delivering goods and taking children to daycare or activities. The main advantage of this kind of conservation is that, at least in principle, it can occur much more rapidly than the efficiency gains from the gradual turnover of the vehicle fleet to smaller cars and a larger number of hybrids and alternative fuel vehicles.

It remains to be seen whether the fuel savings we are now observing will persist and expand, level out, or rebound. The first appearances of $2 gasoline in 2004 and $3 gasoline in 2005 delivered milder shocks to a healthier economy, slowing the growth of gasoline demand but not reversing it in the way that sustained $4 fuel has. That result could be put to the test, if oil prices continue to slide from their $145 high last week, or once the economy finally starts to improve. In the meantime, the scope for further behavior-based conservation remains significant.

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