GAS PRICES, BROCCOLI AND DOUGHNUTS ECNS 594 Montana Council on Economic Education June 20, 2013.

GAS PRICES, BROCCOLI AND DOUGHNUTSECNS 594Montana Council on Economic EducationJune 20, 2013

Our lesson today….

• Energy industry in Montana

• Energy security = energy independence?

• Gas prices• Broccoli and

doughnuts

Why only 2 percent?

Teens and the price of a gallon of gas

How many drive to school?

How many drive as a pastime?

How many care about fuel efficiency?

How many ride the bus or ride a bike?

How many drive in a fuel conserving manner?

How many could tell you the price of a gallon of gas?

Wheels & Women…a teachable moment?

• How are oil prices determined?

• Drill baby drill?• Price asymmetry?• SUV sales?

elasticity social costs real versus nominal

Supply and demand

Efficiency and equity

Lots of teachable economic topics…

The downside of rising oil prices

The upside of rising oil prices

The oil price see-saw

Oil prices? What, me worry?

Consumers

Taxpayers

Producers

Society

Energy is Everywhere

Montana’s Energy Industries

Drilling Oil and Gas WellsNAICS 213112009 Employment = 333Number of firms = 49

Support Activities for Oil and GasNAICS 2131122009 Employment = 1,256Number of firms = 159

Petroleum RefiningNAICS 324112009 Employment = 1,069Number of firms = 5

Coal Mining NAICS 21212009 Employment = 946Number of firms = 7

Colstrip SteamElectrical Station2009 Employment = 578Number of firms = 1

Energy security = interdependence, not independence

“proven” reserves

Add recoverable and unconventional…

The Canadian tar sands

The marginal barrel of oil sold

• Does not matter where or by whom

• There is no use thinking nationalistically

OPEC as a united marginal producer

The world price is the price that matters

Drill baby drill

Foreign oil

World market

What’s the backbone of what we pay at the pump?

up from the ground come a bubblin’ crude…

Refiner Acquisition Cost of Crude OilPADD Region 4

(dollars per barrel)

Acquisition Type

Sep-2010 Oct-2010 Nov-2010 Dec-2010 Jan-2011 Feb-2011

Composite 67.50 69.89 76.05 80.64 82.50 77.97

Domestic 69.77 74.84 78.06 82.74 84.71 81.62

Imported 64.79 63.10 73.59 77.88 78.93 73.15

Movement of oil by pipeline between PADD Districts

PADD District Annual-Thousand barrels 2010

From PADD 1 to PADD 4 0

From PADD 2 to PADD 4 44,604

From PADD 3 to PADD 4 9,906

From PADD 5 to PADD 4 0

Total Oil From Other PADD Regions 54,510

From PADD 4 to PADD 2 122,722

From PADD 4 to PADD 3 70,895

From PADD 4 to PADD 5 11,548

Total Oil To Other PADD Regions 205,165

PADD 4 Exports +150,655

Wholesale traded in open market

Imports make up the difference

But how about wind, Montana has lots of it?

NERC Regions

Low expectations for wind energy

Retail gas purchases determined by…

• Supply arrangements and ownership structure– Oil company owned and operated (<2%)– Refining company owned and operated (<3%)– Branded independent (45%)– Unbranded independent (51%)

• Competition for consumers– Traffic patterns (one third will go out of their way

to save just 3 cents per gallon)

Other regional influences…

• Taxes• Location to refineries (jobbers buy at rack)• Fuel blend requirements• Rent (usually not downtown)• Replacement cost pricing (average retailers

take several deliveries per week)• Brand (market support, discounts, “market

inversion”

The world consumes 80 million barrels of oil per day…….

• World events determine world prices which determine local prices

• Political unrest• Growth in Asia• OPEC• Hurricanes• Refineries (conversion to ethanol additive)

How elastic is supply and demand?

Gas price asymmetry float like a butterfly sting like a bee

Are oil markets efficient?

Oligopoly Power

OPEC

External Costs

Nationalized Oil

Now for the broccoli and doughnuts…

U.S. encourages consumption!

So how do we get more Americans to eat broccoli?

Is $4.00 per gallon the tipping point?

Consumer behavior

• Nominal v. real prices

• Gas complementary good to autos

• Price elasticity of demand

Early attempt to encourage broccoli consumption

D2D0

D1

Quantity/Time

Price/UnitSmall Car Market

D0D1

D2

Quantity/Time

Price/UnitLarge Car Market

Do high gas prices sell small cars?Sales = βo + β1 (Fuel Price) + ε

Model Coefficient on β1 Adjusted R-Squared

Chevy Aveo +17.902 0.321***

Honda Civic +105.660 0.425***

Toyota Yaris +25.808 0.448***

Toyota Prius Hybrid +51.217 0.392***

Cadillac CTS +10.298 0.200**

Ford Expedition -7.663 0.44

Toyota Sequoia +4.772 0.102

Chevy Colorado -7.025 0.050

Toyota Tundra +48.143 0.257***

Why hybrids are difficult to sell

Discount Factor (3%) 1 1.03 1.0609 1.092727 1.12550881 1.15927407 1.1940523 1.22987387

Year 1 2 3 4 5 6 7 8

Gas Price ($3.00 *1.05) 3 3.15 3.3075 3.472875 3.64651875 3.82884469 4.02028692 4.22130127

Gas Cost 1200 1260 1323 1389.15 1458.6075 1531.53788 1608.11477 1688.52051

PV of Gas Cost Reg Car 1200 1223.30097 1247.05439 1271.26904 1295.95387 1321.11802 1346.7708 1372.92169

Total PV of Gas, Reg Car 10278.3888

Fuel Cost, Hybrid 360 378 396.9 416.745 437.58225 459.461363 482.434431 506.556152

PV of Fuel Cost, Hybrid 360 366.990291 374.116316 381.380711 388.786162 396.335407 404.031241 411.876507

Total PV of Fuel, Hybrid 3083.51664

Value of Time Savings 250 242.718447 235.648977 228.785415 222.121762 215.652196 209.371064 203.272878

Total PV of Time Savings 1807.57074

Annual Mileage 12,000MPG Chevy Volt=100MPG Chevy Cruze=30

Value of Time $50 per hour Gas Station Time Savings =300 minutes Per year

Total PV of Gas Savings 7194.87215

Total PV of Time Savings 1807.57074

Total Savings 9002.44289

Only two ways to fund highways

taxpayers

highway users

2 criteria for judging policy

efficiency• Users pay marginal social costs

of highway use

equity• Poor versus rich, rural versus

urban

Subsidize marginal social benefits• education• worker retraining programs

Tax marginal social costs• pollution• Liquor and tobacco

Social costs per gallon resulting from fuel consumption

Rural Passenger Vehicles

Urban Passenger Vehicles

Rural Trucks Urban Trucks0

10

20

30

40

50

60

70

80

90

External Costs per Gallon Fuel Consumed(2009 cents)

Social costs per mile traveled

Pavement Damage

Congestion

Accidents

Noise

Air Pollu

tion$0$5

$10$15$20$25$30$35$40$45

Rural Passenger VehiclesUrban Passenger VehiclesRural TrucksUrban Trucks

Designing Policy:doughnuts to broccoli

• External costs are related to fuel use AND miles driven

• How can we change behavior, without sacrificing equity?

Passenger vehicles account for over 90% of total miles driven

Urban Passenger Vehicles

63%

Rural Passenger Vehicles

29%

Rural Trucks4%

Urban Trucks4%

Share of Vehicle Miles Traveled, 2008

Passenger vehicles also account for over 75% of fuel consumed…

Urban Passenger Vehicles57%Rural Passenger Vehicles

21%

Urban Trucks12%

Rural Trucks10%

Share of Fuel Consumed, 2008

Fuel tax Vehicle miles

traveled taxIncome tax

3 approaches to change behavior

Equity• User pays• Burden on poor and rural• Increases costs of goods

Efficiency• Low administration costs• Incentive to curtail use

Fuel Tax

Equity• User pays• Burden on poor and rural

Efficiency• Incentive to reduce use• Administrative costs

Vehicle Miles Traveled (VMT) tax

Equity• All pay, not just highway users• Avoids burden on poor and rural

Efficiency• No incentive to reduce driving• Administration costs negligible

Income tax

$1 Trillion in profits and still at the trough?

$952 billion “Don’t need 100 year old subsidies to sell $100 per barrel oil”

$36.5 billion in subsidies

Subsidies and the price of gas

Unrest in Middle

East

Weak Dollar

Global Growth

Japanese Energy Supply

Oil companies inherit oil prices more than drive them

Even monetary policy

Resources for teachers

• Historical look at oil company subsidies– www.crs.gov

• Short term energy outlook:– www.eia.gov/emeu/steo/pub/contents.html

• Annual energy outlook:– www.eia.gov/oiaf/aeo/index.html

• International energy outlook:– www.eia.gov/oiaf/ieo/index.html

• Monthly energy review:– www.eia.gov/emeu/mer/contents.html

Questions?