Crude Economics

Driving through Beverly Hills the other day a sign caught my attention. In the visually cluttered metropolis of Los Angeles, that a sign was noticeable is interesting in and of itself. That the sign was from a gas station is even more surprising. That it listed gas at $5.05 per gallon was shocking. This station is in the heart of Beverly Hills, attendants help fill the tank and it was for premium grade. Regular was a bargain at $4.99. It got me to thinking about Michelle Bachman’s promise that if elected she’d bring back $2 gas.

Democrats and comics had a field day. The idea that the President could impact gasoline prices is just preposterous! Right? Don’t tell that to President Ford who created the Strategic Petroleum Reserve in 1975 as a response to the 1973 oil crisis. President Clinton stopped stocking the reserve in 1995, redirecting the funds to other energy projects. President George W Bush (#43) was the first President to tap the Reserve in 2001 as way to “provide energy stability” after the events of 9/11 and the U.S. attacks on Afghanistan. He also returned to the policy of the Government buying and storing oil. In June 2011 President Obama became the second President to use the Reserve – releasing 30 million barrels. He did so out of the uncertainty that the conflict in Libya was causing. Political critics interpreted the action as an attempt by the President to lower fuel costs and help the middle class. (30 million barrels lasted about a day and a half and had no noticable effect on pricing, though the news story showed that the President did something.)

The cost of crude oil only represents 68% of the price. Refining, marketing and taxes make up the rest. The cost of crude was stable for the majority of the last century, and only had wild swings during the first part of last decade (the Owes). Prices tripled from 2003 to 2008.

Why did crude go up so much? Some analysts suggest that because oil is a finite resource the laws of supply and demand are at work. Military conflicts in the Middle East (where most of the exploration is) could be a reason. Others imply nefarious conspiracies that oil prices increased so much under a President who had deep personal and business ties to the industry. Costs of exploration and extraction have increased. Likely there’s a combination of many factors that have resulted in the increase. Three years later it’s unlikely that prices will return to their historic average, and certainly there's no policy efforts from the U.S. Government addressing the issue.

Crude oil is the commodity that fuels the planet. It is not only used in various forms for energy and gasoline, it is the core component of synthetic materials such as plastic. The global economy has been structured around oil.

High crude prices mean high transportation costs. That impacts not only errands around town, but virtually every product and service. Bought a new shirt or blouse? Most likely it was manufactured in an inexpensive labor market like China – but it got to the store shelf via a barge and a series of trucks --- all dependent on gas. Most of us have gotten used to the “fuel surcharge” on a variety of services and goods that we buy.

The higher that fuel and transportation costs go – the economic benefits of outsourced manufacturing must be re-evaluated. There will be a tipping point where the lower wage and regulation costs outside of the U.S. are offset by increased transportation costs. Aggressive and nimble companies would be well served to look at towns and cities across America and reconsider the benefits of domestic manufacturing.

Free trade has had an extraordinary impact on the U.S. economy. Goods and services from virtually anywhere on the globe can be bought and sold in American stores. The idea is that if goods come into the U.S. and are sold from a particular country then that same country would also facilitate the sale of U.S. goods in their country – and not only do consumers around the globe benefit, but companies and countries as well. Good for one is good for all.  The concept has failed in practice.

The U.S. has held a trade deficit – where Americans buy more than sell – since the late 1960’s, and monumental increases since 1995, and hitting its worst point in 2006 of $817.3 billion.

The global financial calamity of 2007-08 has been largely blamed by the “experts” on the bursting housing bubble. There’s no doubt that those issues contributed to the meltdown. But so did the trade deficit and a tripling of oil prices.

Politicians promise to fix things. A simple and effective solution would be to reinstate some tariffs on goods made outside of the U.S. Tariffs have been around forever, and officially part of the U.S. economy since 1792 when it was 15.1%.  The fee hit a high of 44% in 1870. Since World War II ended the rates have been below 10%. 2011’s average tariff is at its lowest point in American history: 1.3%. Doubling of the tariff would mean $500+ billion to the U.S. treasury and restore the rate to 1995 (when the economy was pretty strong).

Increased tariffs, high oil and transportation costs would further incentive manufacturing to return to the U.S. That would mean jobs. People with jobs pay taxes and buy goods (that have to be made). People with jobs no longer require government programs, reducing government spending obligations. A 1% increase in the tariff would have an immediate, short term and long term benefit to the U.S. economy on multiple levels. Washington politicians will instead spend the fall having philosophical jousts - a crude irony when a solution is available.