“Be kind, for everyone you meet is fighting a hard battle” - Often attributed to Plato but likely from Ian McLaren (pseudonym of Reverend John Watson)

Sunday, March 04, 2012

Newt Gingrich on energy, part 1

In a half-hour long video (also embedded below for your viewing pleasure) Newt Gingrich outlines his energy policy that, according to him, will result in gasoline prices for US consumers of "$2.50/gallon or below."

Can Gingrich make this happen? I'm talking about technically and economically, never mind politically. His fundamental premise is (unsurprisingly) that burdensome regulations stifle production of otherwise ample fossil fuel (oil, in particular) resources on public lands. He contrasts production from the Bakken formation in Montana and North Dakota, which takes place on private lands and is, in fact, thriving to the decreasing production on public lands. Gingrich states that the benefits of deregulating oil exploration and extraction on public lands would reduce dependence on foreign oil imports, dramatically reduce our balance of trade deficit, and reduce our budget deficit (via collection of royalties for production on public lands).

It's certainly true that increased production, should it be possible, would have those salutary effects but the key questions are: what reserves are technically recoverable?; what reserves are economically recoverable?; what production rates can be achieved? and; with this information, what is the likelihood of such production reducing the average price per gallon of gasoline to the level claimed by Gingrich?

I'd like to go backwards first and determine an estimate for what price of crude might lead to $2.50/gallon gasoline and then determine what sort of U.S. crude production might lead to such a price. I'll use the methodology (and some of the numbers) from Geoffrey Styles' very interesting and informative Energy Outlook site. Starting at $2.50/gallon, we take out $0.488 for federal and state taxes and $0.15 for retailer/distributor margin. This leaves $1.86 or (at 42 gallons/barrel) about $78 per bbl for pre-tax wholesale. Now we need to correct for the difference in gasoline vs. light crude prices (since there are many other products that come out of a barrel of crude). I'll use Skyles' figure of $9.67/bbl for this number and we're looking for crude at about a bit under $70/bbl as our magic number.

Let's check and see if this is in the ballpark. I'll again defer to Skyles as to which crude price follows gasoline most closely and go with Brent Crude. At this page from the Energy Information Agency we can look at monthly historical spot prices for Brent crude, and this page gives us monthly U.S. regular conventional gasoline prices. I downloaded the relevant spreadsheets and plotted Brent crude as a function of gasoline price. The "visual" impression is of a very good linear correlation. Excel gives Brent=36.76*gasoline-23.768 with an R^2 of 0.9717. Plugging in $2.50/gallon yields a predicted Brent price of $68.13. Not bad, I think we're on to something here.

Thus, Gingrich's plan must produce a sufficient supply (accumulated production minus consumption) sufficient to drive Brent crude down to around $68/bbl. In my next post, we'll look at what level of production in the U.S. might lead to such a price and whether it's reasonable to expect that any policies Gingrich might undertake could lead to such a rate of production. Finally, we'll look at whether the economics justify the expense of production from any technically recoverable reserves that could potentially lead to such rates.