Thursday, December 24, 2009

The Price of Energy

The price of gasoline (petrol) has been rising the last few months in the US. The price of natural gas (methane) on the other hand has been falling for the past year. Seattle City Light, which gets most of its power from hydro, recently announced a 13% rate increase on electrical rates.

People often ask me to explain these seemingly contradictory trends. After all, a kilowatt-hour is a kilowatt-hour everywhere. A BTU is a BTU. The short answer is that it's a free market, and the "invisible hand" has its reasons. But a quick look at each of these energy sources explains a lot just the same.

This is the first of a two-part blog on the Price of Energy. Let me say first, however, that the Price of Energy is nowhere near the Cost of Energy. This is perhaps the biggest market failure of all time. We are just realizing the social, health, and environmental costs of energy. But they have yet to be factored into the price.

In any event, here's a short primer on the Price of Energy.

GASOLINE - There is nothing like gasoline. Nothing so energy dense, transportable, and easy to handle. Gasoline is a miracle made manifest. Gasoline comes from oil, and oil is a global market. The oil comes from everywhere and is cracked in each market to produce gasoline. So the price of gasoline follows global economic demand. Even if your country is experiencing a recession, the price of gasoline may rise due to increased demand (or decreased availability) on the other side of the world.

In the US we have the added complication that by international consensus, oil is priced in US dollars. So when oil is in demand in another country, not only is there greater market demand driving the price of oil up, but the transaction increases the demand for dollars, and the currency exchange in the transaction drives the value of the dollar up. This makes exports from the US difficult, and slows the US economy. The higher gas price combined with the stronger dollar puts a real brake on things. It works the other way as well, of course, and the US has benefited from that. But my point here is that gasoline prices in the US are a little harder to explain than elsewhere. It's a sort of double-feedback loop.

NATURAL GAS - Natural gas, or methane, either comes up along with the oil, or comes out of dedicated gas wells. Natural gas is, well, a gas at atmospheric pressure and temperature, and as such it is hard to transport globally. Generally the gas industry uses continent-wide pipeline networks. But crossing oceans is difficult. Some firms chill it to liquefy it, and then transport it in cryogenic tankers. But this in itself is energy-intensive, and makes it difficult to compete with domestic sources that come through a pipeline. The upshot is that natural gas tends to be a domestic, or at best continental, market that does not respond to economic conditions elsewhere. It may in fact move in the opposite direction in any given market.

Part 2, Propane, electricity, and (ugh) coal, next week.

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