Yesterday, December 3, I went to the International Energy Agency’s presentation of its 2010 World Energy Outlook in Washington, D.C. I ended up with two takeaways, a claim that the demand for petroleum was less price-responsive than it had been and a claim about the huge fossil fuel subsidies being provided around the world, especially by those governments that are major exporters of fossil fuel. Iran was identified as the leading “offender.” These takeaways were reinforced after the presentation in talking with people I knew in the audience.
I mentally challenged the issue of a lowering of the price responsiveness of petroleum demand. During the great petroleum price spike of 2008, the US made a political decision to finish filling the Strategic Petroleum Reserve. This political decision was likely to distort any estimation of the price responsiveness of petroleum demand. This was part of the reason I mentally challenged the claimed lowering of the price responsiveness of petroleum demand. As an aside, two days earlier a friend had commented about testifying against the decision to finish filling the SPR, so that nugget was in my mind. Also, I remembered a presentation about that time that China had also been making political decisions during the same time period that could have influenced the demand for petroleum further distorting the price responsiveness of petroleum demand.
I believe that the use of storage has a major impact on the price of commodities, whether the petroleum discussed specifically in this blog entry, or natural gas, electricity, and wheat. I remember the Soviet agricultural crisis in the 1970s (?). The federal government allowed the Soviets to export US wheat in large quantities. Our wheat storage was full, almost overflowing. Too late it became known that much of the wheat in storage had already been bought by the Soviets, who just needed the export licenses. The wheat prices soared once people realized that the wheat in storage was not owned by domestic speculators but was owned by the Soviets intent on exporting the wheat. Thus, I am sensitive to the amount of a commodity in storage, as well as the amount going into and out of storage, in determining the price of the commodity. And when those decisions on storage are political, should that be considered a change in the price responsiveness of demand?
After the presentation, an Iranian I know came up to me quite incensed. He said that the claimed decline in the price-responsiveness of petroleum was in conflict with the call for Iran to reduce the “subsidies” for fuel. Further, they had the numbers wrong.
- If indeed the demand for petroleum is not price-responsive, why would a government’s decision to subsidy the price of petroleum products matter, such as in Iran. His argument seems correct, at least if the concept of a decline in price-responsiveness had finally reached zero, which had not been the claim of the IAE, at least not that could be determined from the presentation.
- IAE said that the price of gasoline in Iran was $0.08/liter. The Iranian claimed the price was almost 40% higher, $0.11/liter. In English units, these prices would be about $0.31/gallon and $0.40/gallon, perhaps an eighth of the price of gasoline in the US and much less than a tenth of the price of gasoline in Europe. He didn’t seem to mind that his quibbling was about a factor of 1.4 when others were talking about factors of 8 or 10.
We also talked about “smuggling,” people buying tanker trucks full of gasoline in Iran (whether at the $0.08/liter price of the $0.11/liter price was irrelevant) and selling the gasoline across the Turkish border. I thought that the transfers of a legal commodity across the border made sense, in that it should reduce the price of gasoline in Turkey, or at least that region of Turkey, and raise the price of gasoline in Iran, at least in that part of Iran. The Iranian’s ire seemed to be directed toward the concept of violating government policy, one of not exporting gasoline from Iran, or at least not allowing small entrepreneurs to make money from the practice. I guess his point was that the practice should be limited to licensed vendors.
This week Iran had shut down most of Tehran on three different days because of severe pollution, nominally caused by gasoline driven cars. Shades of Los Angeles, Denver, and parts of China. Eliminating the Iranian gasoline subsidies would reduce driving in Iran, including Tehran, at least if the IEA claim of reduced price sensitivity could be ignored.
During the presentation on subsidies, I began to wonder how subsidies should be defined. My work on utility rate cases would often identify subsidies as relating to paying one’s fair share of the cost of the operating the utility. Fair share included subjective decisions about cost allocations, so there were debates as to whether industrial customers were subsidizing residential customers or vice versa. But these debates had as an underlying premise that the measurements were to be relative to the cost actually incurred by the utility. Under that mind set, was the Iranian government recovering all of the cost it incurred in producing oil? Yes, the world price for gasoline was much higher than the Iranian price, but did the enterprise as a whole lose money?
I have heard that Iran is currently considering raising the price of gasoline and of other energy supplies. The revenue generated by this process would be used to provide Iranians with cash. One thought is that the cash would be distributed equally per person, much as Alaska distributes cash to its residents from the taxes on oil production. Last Wednesday, another friend had said that beneficiaries of the very low gasoline prices were those few Iranians driving huge gasoline guzzling SUVs. Thus, the reform of gasoline prices, when coupled with an Alaskan style distribution, would hurt a few, the owners of the gas guzzlers, and benefit many, anyone who doesn’t own a car and uses little energy.
The conversation about Turkey and the huge price differential between Turkish gasoline and Iranian gasoline made me think about the people who would really be severely hurt by an increase in Iranian gasoline prices, the smugglers. It would make sense for them to be very adamant about keeping the status quo, much as the illegal gambling industry sought to prevent legislation legalizing sports gambling in the Bruce Willis movie The Last Boy Scout.
The IEA discussion about subsidizing fossil fuel commodity prices left undiscussed other subsidies that exist in the energy industry. In the electric industry, renewable resources are heavily subsidized, whether by the tax credits offered by various governments, the renewable portfolio standards of various US states, or the feed-in tariffs that exist in many European countries. My concern as an electrical engineer is that such subsidies are making the supply of electric energy to be less price responsive than it had been, perhaps even more so than the effect on the demand for petroleum. Last year I looked at the prices paid for electricity generated in ERCOT, the Electricity Reliability Council Of Texas. (See “Renewable Electric Power—Too Much of a Good Thing: Looking At ERCOT,” Dialogue, United States Association for Energy Economics, 2009 August available for free download on my web page. Just register your name and data.) For a quarter of the month of April 2009, the prices in West Texas, with a lot of renewable generation, were negative. The wind generators had to pay ERCOT to take the electricity off their hands. And the negative prices reached Houston for about 1% of the month.
The concept of negative prices in juxtaposition to the concept of subsidies leads to the issue of taxes on energy, essentially negative subsidies. These negative subsidies have led to very high gasoline prices in Europe, though according to the IEA less sensitivity to price analysis, these high gasoline prices are no longer restraining the consumption of gasoline in Europe.