Global Economic Downturn Primary Reason for Drop in Fuel Prices

Source Article: Drop in Gas Prices only Temporary - Colorado Springs Gazette
(See Article)

Implications:

1) Basic Transportation infrastructure hasn't changed
2) Investment in alternative fuels needs to continue
3) Current volatility in supply costs has wiped out ethanol industry in US

Analysis:
$4.00 a gallon gasoline this summer, $1.65 a gallon now. OPEC supply cuts don't cause an immediate price spike. Even with lower prices, US fuel consumption dropped 2.7% in December. What the heck is going on?

The worldwide economic slowdown has caused disruptions in major industries across the board, but nowhere does the average US consumer see and feel it so personally as at the gas pump. Prices coming down over 50% in three month in a major consumable should be cause for celebration, but the consumers are still shell-shocked from the price run-up.

The consumer now has to face the stark reality of their position in the energy supply chain...not just end user, but end user who is locked into a consumption pattern they cannot readily change!

Auto loans kept getting longer and longer, now the norm is 5 years, and with what's been going on the consumer credit and automobile markets, the consumer was (and is) driving what they own, or rather, what they are paying on.

Similarly, the vast majority of "Suburbia" was developed on the premise that there will be affordable personal transportation to service the layout of the built-out post WW II US residential infrastructure.

You can't just sell your house to move somewhere with good public transport. You can't reasonably expect local governments to instantly deliver transportation solutions to a population that hasn't wanted them, and until recently, needed them. Funding for public transportation outside of major urban areas hasn't been a particularly important or urgent item on most taxpayer's radar screens.

The prices of motor fuels have been so volatile, that the current low ebb has had another unintended result. The ethanol business in the US had every expense and revenue assumption they based their business models on wiped out in the price swoon of oil. Corn prices and most other agricultural commodity prices have headed down as a result, hammering the farmer and ethanol producers alike.

You couldn't have planned for a more cautionary tale to be told about "alt-fuel" investments. Every time the non petroleum fuels movement picks up steam, it faces the reality that it's own market penetration creates the seeds of it's downfall. The less oil thats consumed, the lower the oil prices go.

The infrastructure and extraction costs of oil are low in comparison to creating an entirely new stream of biofuel or alternative fuels, with the build out of distribution and consumption systems to go with the renewable supply.

Corn ethanol was clearly a misguided effort, "Cellulosic" (non food product feedstock) ethanol seems to be a step in the right direction, but you are building an industry with 21st century dollars and real production costs to compete against a business with 20th century costed and built out infrastructure and extraction costs as the production cost component. The oil that is "Produced" by the oil business is really extracted.

While the US model is for private oil firms to control the supply, in most of the world state-owned oil firms have no incentive not to "Overpump" to achieve revenue targets to support their governments, and not worry too much about per-barrel profits or ROI of the investment made to get the oil. They are revenue, not profit driven, in the main. A petro-economy like Venezuela uses PDVSA as a cash flow device, not an instrument to create return on investment.

So as increasing biofuels production reduces demand for oil, the inclination of the state-owned firm will be to "pump more" to maintain cash flow, and lowering the market price for crude, and consequently, motor fuels.

This is why there needs to be a more rational program at the Federal level here in the US to encourage alternative fuel sources. Whether that's the new "Petro-algae" engineered microbes converting biomass to fuel, or "Switchgrass" ethanol programs taking marginal food production land and using it to grow the ethanol feedstock, the investors in these technologies and businesses need to know they have a "floor" price, guaranteed legislatively, that allows them to plan for a return on the investment needed. If the floor price doesn't activate, it's cheaper than subsidies. If the floor price does activate, it should be for a finite period, so it doesn't foster inefficiencies in the "new" fuel supply chain.

The global economic slowdown has shown how the oil markets will act in a period of reduced consumption. In order to develop a secure alternative fuels industry, the pioneers in that business will have to be insulated from "supply shock" to prices as consumption would drop.

The economic situation with the slowdown is temporary, but the investments in alt-fuel need to be long term. Prices are going head back up as the world economies recover, but action now will help mitigate future shocks to the system.