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July 5, 2008

Recycling Bad Ideas: Bringing Back 55

by tarran

Senator Warner has a brilliant idea how to reduce gas prices; force Americans to consume less at gun point:

Sen. John Warner, R-Va., asked Energy Secretary Samuel Bodman to look into what speed limit would provide optimum gasoline efficiency given current technology. He said he wants to know if the administration might support efforts in Congress to require a lower speed limit.

Warner cited studies that showed the 55 mph speed limit saved 167,000 barrels of oil a day, or 2 percent of the country’s highway fuel consumption, while avoiding up to 4,000 traffic deaths a year.

“Given the significant increase in the number of vehicles on America’s highway system from 1974 to 2008, one could assume that the amount of fuel that could be conserved today is far greater,” Warner wrote Bodman.

Warner asked the department to determine at what speeds vehicles would be most fuel efficient, how much fuel savings would be achieved, and whether it would be reasonable to assume there would be a reduction in prices at the pump if the speed limit were lowered.

The department’s Web site says that fuel efficiency decreases rapidly when traveling faster than 60 mph. Every additional 5 mph over that threshold is estimated to cost motorists “essentially an additional 30 cents per gallon in fuel costs,” Warner said in his letter, citing the DOE data.

This law is patently unconstitutional: nowhere in the United States Constitution is the Federal Government permitted to pass laws governing speed limits. The Congress can get around this limit on their power using the usual dodge of merely passing voluntary regulations and withholding highway funds from states that refuse to go along.

This proposed law is ridiculous on many levels. First, the optimum speed varies from vehicle to vehicle. A one size fits all law would really require some people to drive at suboptimal speeds. The law would have the effect of limiting innovation: why research ways to make fuel efficiency at 70 mph better if nobody is allowed to drive at that speed? Just as when the courts in the 19th century gave polluters carte-blanche to pollute on their neighbors’ properties and killed the nascent emission reduction industry – this law will kill all such groundbreaking research.

Second, contrary to Sen Warner’s assertion, a reduced speed limit does not save lives. In fact, quite the opposite:

Taken as a whole, these different analyses lead to the conclusion that overall statewide fatality rates fell by 3.4 to 5.1 percent in the states that adopted the 65 mph limit.

Why did the new speed limit lower the fatality rate? 1) Drivers may have switched to safer roads; 2) highway patrols may have shifted resources to activities with more safety payoff; and 3) the speed variance among cars may have declined — it might decline on the interstates as law abiding drivers caught up with the speeders, and it might have declined on other highways as their speeders switched to the interstates. The evidence indicates that events 1 and 2 did occur; we have no evidence for event 3. Future research ought to be directed toward disentangling the relative contribution of these factors.

What about its impact on the price of oil?

True, such a law would result in lower consumption of gasoline on the roads, both because of lower fuel consumption and because people would curtail long road trips (because they would take too long). But the reduction in demand for driving would have no impact on the other manifold uses of petroleum. People living in the United States consume upwards of 9 billion barrels a day. If we are charitable, and assume that this time around the savings in consumption will be 100 times larger – that would still amount to 16 million barrels a day, or less than 1% of the oil consumed in the United States each day. Obviously this move would have a barely perceptible effect on the price of unrefined oil.

What about the impact on the price of gasoline?

Well, the price of gasoline is set almost entirely by the supply available. The run up in price could be due not only to to a shortage of available oil, but also due to the availability of refining capacity. And indeed, the oil industry has been expanding its refining capacity at a much lower rate than the rate at which gasoline consumption is growing. Last year, refineries supplying the U.S. market were pumping out 98% of the maximum amount of gasoline that they can theoretically produce.

In such a circumstance, a small drop in the consumption of gasoline could have a major impact on the price. So Senator Warner could be right, forcing everyone to drive more slowly could result in a 10% reduction in the price of gasoline… in the short term. Of course, 5 – 10 years from now, demand would have risen to current levels, and we would be right back where we are today.

The obvious question is why aren’t refiners expanding capacity? After all, gasoline is liquid gold. If they make it, they will be able to sell it at a profit. We should be seeing refiners adding capacity to their operations. Are these refiners idiots? Are they walking away from money? Apparently not! Two years ago, they were trying to avoid wasting money because they didn’t want to invest in major expansions until they figured out what regulations the government is going to impose upon them.

In hearings before Congress [in 2006], oil executives outlined plans to increase fuel production by expanding their existing refineries. Those plans would add capacity of 1.6 million to 1.8 million barrels a day over the next five years, for an increase of 10 percent, according to the National Petrochemical & Refiners Association.

But those plans have since been winnowed to no more than 1 million barrels a day, according to the Energy Information Administration, an arm of the federal government.

“If the national policy of the country is to push for dramatic increases in the biofuels industry, this is a disincentive for those making investment decisions on expanding capacity in oil products and refining,” said John Hofmeister, the president of Shell Oil. “Industrywide, this will have an impact.”

So, because refiners are afraid that their investment in additional capacity can be rendered worthless at the stroke of a presidential pen, they are holding off making any such investment. And I can hardly blame them.

The 55 mph speed limit was one of many dumb ideas that came out of the Federal Government in the early 1970′s. Thankfully, it was abandoned in the 1990′s for reasons that are still operative today. It is a shame that an economic ignoramus who manages to win an election could have he power to reinstitute such a dumb law. Senator Warner would be making a better use of his time and political capital if he worked towards ending the disastrous “Energy Independence/Sustainability” initiatives that are wreaking such havoc with the production of energy world wide. Let’s leave the disastrous ideas of the 1970′s in the dustbin, where they belong.

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12 Comments

  1. tarran,

    Are the refiners actually making big profits? With the cost of oil, producers are making enormous profits, but that oil is an input cost to the refinery. They’re undoubtedly making record revenues, but I’m not sure their profit margin has gone up commensurate with those increases in price.

    Comment by Brad Warbiany — July 5, 2008 @ 4:49 pm
  2. I don’t know if they are making big profits. However, they must be making money pretty reliably; otherwise you would see more idle capacity as marginal producers stopped using unprofitable capacity.

    The websites I linked to disagree significantly concerning the role bottlenecks in refining capacity are playing in the run up of prices. Like you, I strongly suspect that the refiners are having a difficult time. Otherwise they would be willing to take on more regulatory risk and build additional capacity in spite of the political uncertainty.

    Comment by tarran — July 5, 2008 @ 5:34 pm
  3. actually refiners are making barely profitable margins. in fact the only reason refiners like Citgo on the gulf coast even make a margin at all is due to special govt subsudies directly to their industry. i live in one of the petrochemical corridors of the gulf coast and that’s how it’s been for decades. when oil was cheap, these companies made mad ass $$ and still raked govt subsidies to boot. ever since 2002 however it is the subsidies that even keep these “private” operations viable and also it’s why we aren’t paying 5+/gallon right now.

    so the obvious answer, besides prohibitory environmental regulation process to establish new refineries or increase capacity, and the NIMBY (not in my backyard) principal, is that the industries will not increase capacity in an unprofitable enterprise.

    also i do know what i’m talking about here, having family knowledge, academic knowledge, work experience, and investment research of this industry.

    Comment by oilnwater — July 5, 2008 @ 10:52 pm
  4. Excellent post.

    As to the price of gasoline, I was wondering how much of an effect another factor might have.

    In January 1998, gold was $289.15 per ounce and gas was $1.13 per gallon. In January 2008, gold was $889.60 per ounce and gas was $3.13 per gallon.

    This shows a 208% increase in the price of gold in dollars, and a 177% increase in the price of gas in dollars.

    In an attempt to remove the effect of dollar inflation, I figured the cost of a gallon of gas in gold. In 1998, a gallon of gas cost 0.003908 ounces. In 2008 a gallon of gas cost 0.003524 ounces. This means – when we take inflatable dollars out of the equation – that the cost of gasoline in a stable medium of exchange has actually dropped 10% in the last 10 years.

    Could the reason that gas is so expensive in dollars compared to 10 years ago be more about the decline in the value of dollars, and less about an increase in the value of gas?

    Perhaps if Senator Warner – from the alleged party of smaller government – wants to address the problem of soaring energy costs he should look at methods to curb inflation, rather than to resurrect arbitrary, failed, and unconstitutional federal controls on citizens.

    Of course that would undoubtedly require spending less Fed Monopoly money on empires and entitlements.

    Comment by Akston — July 6, 2008 @ 2:41 am
  5. oilnwater – Is there any website that gives good, reliable analysis of the oil industry? When I was writing this piece, I had a devil of a time finding sources hat I dared to link to.

    Comment by tarran — July 6, 2008 @ 4:34 am
  6. Akston – your are quite right to look at inflation. I ignored it in my analysis because I was not so much concerned with why prices went up but with the effects of reimposing a national speed limit again. The larger number of dollars flowing through the economy would have pretty much the same effect on prices independently of whether or not this new regulation was put in place, so I ignored it.

    Comment by tarran — July 6, 2008 @ 4:38 am
  7. -since your article specifically addressed the refiners, apart from the rest of the oil industry (which has been making astronomical $$), this kiplinger’s article does a decent job of explaining “crack spreads”. the profit margin gained from fractional distillation of raw crude

    http://www.bloggingstocks.com/2008/05/16/kiplinger-oil-refiners-not-as-profitable-as-we-might-think/

    -NIMBY is another very important factor here in the US as to why refiners don’t try harder to establish new capacity http://en.wikipedia.org/wiki/Nimby

    -the EPA, both state and fed counterparts, raises the costs of establishing new facilities or expansion of existing facilities by the 100s of millions by imposing New Source Performance Standards (NSPS) technology on all emission points under the Clean Air Act. the Clean Water Act adds to the bill for the plant’s waterway usage. much of these costs are also renewed periodically and requires the company to staff a highly paid environmental regulation team in house.

    -South Dakota seems to be on the right track:

    http://gas2.org/2008/06/04/new-south-dakota-oil-refinery-one-step-closer-to-reality/

    -what CATO had to say about govt subsidies to refiners (back when gas was 2.22/gallon, those were the days…)

    whose hands do subsidies go into though, actual operations, or “other” people… i couldnt say.

    Comment by oilnwater — July 6, 2008 @ 7:26 am
  8. sorry, cato link

    http://www.cato.org/research/articles/taylor-050603.html

    Comment by oilnwater — July 6, 2008 @ 7:28 am
  9. in fact the only reason refiners like Citgo on the gulf coast even make a margin at all is due to special govt subsudies directly to their industry.

    Are you really suggesting that if we took away the subsidies, those refineries would no longer be profitable? Unless their global competitors are benefiting from extravagant subsidies (in which case an import tariff would be a more appropriate approach to leveling the playing field), they should have no trouble charging a fair price for a service that’s in such great demand.

    Comment by Jeff Molby — July 6, 2008 @ 10:52 am
  10. Jeff,

    I think he’s saying that the subsidies are allowing them to operate at a loss and we’d be seeing $5.00+ gasoline without them.

    There is no question that refineries can make money; they;d just sell less gas at a higher price.

    Comment by tarran — July 6, 2008 @ 11:24 am
  11. There is no question that refineries can make money; they;d just sell less gas at a higher price.

    Ok, so we — assuming your response matches his intention — agree that the subsidies aren’t necessary. Are you suggesting they’re a good thing? I’d much rather pay the higher price at the pump than pay for it through some backdoor tax.

    Comment by Jeff Molby — July 6, 2008 @ 6:57 pm
  12. the subsidies, especially at the state level, from my understanding are a tradeoff for agreements that the corporation invest money into the state apparatus through university co-op jobs (i took one), among an umbrella of taxes the corporation pays to its residing state. this is partly to migitate the NIMBY factor. i.e., the residents bitching.

    the residents do have a point. i spent everyday sampling ground wells at Citgo, and the water underneath the facility had very bad levels of ethyl benzene. i only imagined what got into our aquifer after decades of operation. they also had to relocate the nearest town, reimbursing every resident because of unsafe water.

    all this is not to say the subsidy-corporate handout tradeoff is great, or that a refinery is From the Devil. but reality from my perspective is that refineries are not the picture of health in the eyes of local residents, other than good, real jobs. personally i’ll take the jobs. and that’s how the vast majority around here take it too.

    Comment by oilnwater — July 6, 2008 @ 7:36 pm

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