Gas prices have been dropping since July, and the overriding factors responsible for this drop are our old friends supply and demand. Even though Government interventions such as regulations, taxes, and electronically printed counterfeit money are factors that have to be adjusted for by the pricing process of the free market, or what’s left of the free market, supply and demand overwhelmingly determine prices.
PRICES COORDINATE PRODUCTION AND CONSUMPTION OVER TIME
Prices are how consumers demands for scarce resources, and producers supplies of scarce resources are coordinated at any particular moment in time. The law of supply and demand states that, more will be supplied and less will be demanded at a high price, and less will be supplied and more will be demanded at a low price. Prices are constantly adjusting for all the variable factors (including Government interventions) that go into the process of production and consumption.
In an article from July titled, Gasoline Consumption Is Down: Why?, we showed that consumption of gasoline in the U.S. has slowly declined by 66% over the last eight years. Look at the full chart here.
Year Thousands of Gallons Per Day (April)
2006 61,020.8
2007 57,354.7
2008 56,307.4
2009 51,215.6
2010 46,016.2
2011 41,555.0
2012 29,684.0
2013 28,179.6
2014 20,109.1
We stated in the July article that “Since demand is low, the price should eventually go down“. This is coming true, even though we forgot to look at the “supply” side, of the law of supply and demand. If we look at the price of oil over the last six years, checkout the chart here, we see that it has been trading on average of around $90 a barrel. We know that more will be supplied at the higher price according to the law of supply and demand. This higher price over time has allowed fracking to become a profitable way of extracting oil from the earth. In spite of the Governments attempt to slow down, or shut down, fracking by taking Federal land off-line for shale oil production, the supply of oil in the U.S. has almost doubled since 08 because of the fracking boom that has taken place on private land in Texas, North Dakota, Pennsylvania, and parts of Ohio. Under normal market conditions, when the underlying commodity (oil) used to produce a consumers good (gasoline) costs less, the price of the consumers good usually goes down.
This chart is from carpediemblog.
THE MARKET CHOOSES FOSSIL FUELS AS THE WINNER OVER GREEN ENERGY
This shale revolution is an example of prices working their magic, by not only discovering new oil reserves, but also in using new technologies to find new methods of extracting the oil. It is sad and funny at the same time to see how this administration went all in for funding (investing in) green energy, only to find out that politicians and bureaucrats aren’t smart enough to be in the venture capital business (here). They thought their green energy “investments” would lead job creation in our new green economy. In fact, if it wasn’t for the jobs created by the shale oil revolution, there would be no job growth in the U.S. since 08.
This chart is from carpediemblog.
Green energy companies that received your tax dollars have gone bankrupt (here). Think of all the tax payer funded resources, capital, time, and labor that has been wasted, because politicians and bureaucrats don’t understand, or don’t care, that price coordinated markets are more efficient in allocating scarce resources to their most valued uses, according to consumer demands, than Government central planners could ever be. Green energy will only become viable when it’s unsubsidized cost is lower than our current way of supplying energy. The discovery of new oil reserves has pushed the chance for green energy becoming a viable alternative to fossil fuels much farther into the future. Unless an exponential advance in green energy technologies happens that reduces the cost per unit of green energy, compared to cost per unit of energy from fossil fuels, green energy will remain a quixotic crusade for the left.
WHAT HAPPENS NOW THAT THE PRICE IS FALLING
The process of supply and demand is always trying to find an equilibrium point. In an ever-changing world, this equilibrium point is always just out of reach of wherever the economy is at any given time. It’s difficult to understand that the future equilibrium point we are moving toward, is a creation of what individuals are doing in real-time. We also have to understand that economic data is a snap shot of what has happened in the past. And knowing that history is by its very nature tardy, we should also know that economic data has already been factored into the future equilibrium point that the economy has been trending toward both yesterday and today. And we also know that point will change tomorrow.
Since the price of oil and gas is falling, we know two things will happen or are already happening. 1) Less gas and oil will be supplied at these lower prices, and 2) more gas and oil will be consumed at these lower prices. The decisions that individuals are making about consumption and production of gas and oil at these lower prices, are already setting the stage for the next price shift upward. When this will take place nobody really knows. Look how long it took for gas and oil prices to go down from their highs over the last six years.
Here are a few things to think about.
1) If demand doesn’t increase a lot at these lower prices, it tells me the economy isn’t as strong as the experts have been telling us. Gas and oil are the energy that drives our economy. As economic activity increases more gas and oil will be consumed. If consumption levels stay close to the levels we have seen in the above charts, we will know how healthy our economy is.
2) If the price of a barrel of oil isn’t high enough to cover the cost of fracking a barrel of oil, fracking will begin to slow, and in some cases wells will have to be shut down. This isn’t good or bad, it is just the reality of changing market conditions.
3) How much of the fracking revolution is a bit of a bubble activity? We know the Fed has electronically printed trillions of counterfeit dollars over the years that, as Jim Grant says, “is money in search of mischief”. This counterfeit money has ended up in the financial markets and is searching for a higher rate of return. I’m sure this counterfeit money has found its way into the fracking industry. This counterfeit money is pulling future production and consumption into the present before it would have come to exist in an unhampered market. Any bubble part of the fracking industry will eventually be liquidated. This liquidation is the cure, it will purge speculative investment from the fracking industry, helping find the right amount of production that can be supported by true market conditions. This liquidation won’t happen if the Fed, along with politicians and bureaucrats, bail out the speculative investors. Lets hope they hate the oil industry enough to allow it to self correct.
4) If demand doesn’t increase at these lower prices, the price will eventually go up. If the amount of gasoline we use remains at a certain level whether the price per gallon is $2.00 or $3.00, what do you think the price will be? Put another way, if overall revenue is greater at the higher price than the lower price, the higher price will be charged.
5) Many say this lower price will stimulate the economy, because people will have money to spend on other things. While every increase in productivity helps the overall economy become wealthier; do we know what part of the increase in productivity in the oil industry is represented by what consumers save at these lower prices? The money that is not represented by an increase in wealth as a result of becoming more productive, doesn’t create anything new. Depending on how each individual chooses to use the money he saves at the pump, it is just going to be shifted from the oil and gas industry to a different sector of the economy.
6) When the price of oil and gas went up, the market (which means individuals) adjusted their activities around the new price. These adjustments ultimately helped produce the lower price that exists today. Individuals will now start to adjust their activities to the new lower prices. Whatever results from these new adjustments, even as the price goes up, is exactly what should happen.
7) Since gasoline consumption has been decreasing for years, State and Federal Governments have been collecting less tax revenue. With the price of gas going down, watch out for politicians and bureaucrats starting to talk about raising the gasoline tax, in order to repair and build highway infrastructure.
CONCLUSION
Prices coordinate supply and demand, according to what each individual desires in relation to the inherent scarcity that exists for any economic good or service. Prices don’t cause this scarcity, prices reveal the degree of the underlying scarcity.
Related Article – Is The Economy; Growing, Shrinking, Or Exactly Where It Should Be?, by austrianaddict.com.
Related Article – Capitalism vs. Crony Capitalism, by austrianaddict.com.
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AUSTRIAN ECONOMICS ADDICT 