Warren Ward Associates

A-Maize-ing Grace?

No one enjoys having to pay more for something than is absolutely necessary but knowing what’s necessary can sometimes be a challenge. Courtesy of the laws of supply and demand, most markets tend to remain pretty much in balance. Grocery stores don’t stock extra milk during the summer in case of a snow storm. Yet, we would be surprised if stores did not do so during the winter – especially if bad weather is forecast. The supply and demand equation is more complicated with power generation than with milk. All of us want enough electricity available so that our air conditioning can run during the hottest part of the summer but no one wants to have to pay to keep an extra power plant standing by year round, just in case.

The same balance holds true for the oil-based fuels we count on to run our vehicles, heat our homes and, sometimes, provide our electricity. The past few years have exposed us to another round of high gasoline prices. These have been brought on by a combination of reduction in supply and hedge fund speculation in the markets. These price spikes have raised questions about replacing some of our [mostly] imported oil with some [possibly] home-grown ethanol. In fact, in his 2007 State of the Union address, President Bush proposed a ten-fold increase in ethanol usage from around 3.5 to 35 billion gallons per year by 2017.

If my initial contention re supply and demand holds true, the current supply of corn should be fairly close to the demand for it. What might be the result of a significant increase in demand for corn? We found out last year when the rise in oil prices led to increased demand for ethanol which, in turn, sent corn prices up. In Mexico, where corn is used to make the staple food tortillas, those rising corn costs drove tortilla prices up 70% between Sept 2006 and January 2007. President Felipe Calderón had to cap the price of tortillas in response to protesters in the streets. Is it possible that producing ethanol isn’t the most important use of corn?

Developing a biofuel strategy may be a politically popular answer to controlling gasoline prices but there are significant issues beyond rising corn prices which must also be dealt with. Since ethanol and gasoline cannot be transported through the same pipelines, either a huge increase in tanker truck capacity or numerous "hometown" processing plants will be required. According to the US Department of Agriculture, ethanol currently costs more to produce than gasoline and would not be at all cost-competitive without the 51¢ per gallon tax subsidy that the federal government provides.

Several other biofuel concepts are being tested around the world including utilizing trees to replace corn as the basic feedstock. When I read about that in "The Economist" recently, I found myself wondering about the potential for conflict when one green concept like reducing fossil fuel use must compete with another, i.e. preserving our forests.

Whether our dependence on oil, imported or not, can be resolved through replacing some of it with ethanol is a complicated question. In my mind, it goes beyond sound bites delivered on the evening news. If our country does proceed down this road, it will not be without substantial costs. As things stand, corn crops are subsidized by the government, ethanol plants receive tax relief and ethanol fuel offers consumers fewer miles per gallon. The question which must be considered is this: How much will each of us be willing to pay, not for energy independence, but simply for reduced reliance on imported fuels?

N I M B Y

One of the truths of modern life is that we have come to enjoy and even expect certain comforts which would have been beyond the wildest dreams of earlier generations. We have become accustomed to indoor plumbing, central heat and air conditioning and the availability of electricity at the touch of a switch. As much as we desire these comforts, there is frequent resistance to the infrastructure necessary to deliver them, hence the acronym NIMBY, meaning Not In My Back Yard.

Back in the early 1950’s, I’m sure the residents of Columbus were very glad to have a wastewater treatment plant installed south of downtown. However, now that "town" has moved closer to that site, plans have begun to move the plant away from the "backyard". Similarly, the building or expanding of power plants has become a "hot button" issue for many Americans, regardless of the country’s potential need for additional electric power. Getting by with fewer plants or building plants which are "out of the way" might be a sensible strategy but that solution requires additional high voltage lines to deliver power to our communities. Although I am unaware of scientifically-based research linking those lines to increased illness, many people are as reluctant to live near them as power plants.

Coal-fired plants provide the lowest-cost electric power but mining operations are not pretty and some people want to do away with coal power, end-to-end. Nuclear power is clean and non-polluting but people can’t forget the scare at the Three Mile Island plant in 1979 or the very real effects of the 1986 failure at the Chernobyl reactor in Ukraine. In doing research on Socially Responsible Investing for some clients, I came across a mutual fund that would not invest in a power company which utilized nuclear power but did not have a problem with coal-fired operations. Who’s to say what is acceptable and not?

With rare exceptions, communities are reluctant to permit major infrastructure projects in their back yards. One atypical response comes from the city of Richland, WA. Richland is near the Hanford nuclear plant which provided weapons grade plutonium for the country during the cold war years. Appreciating the jobs which the plant brought and continues to provide, most of its citizens remain supportive of the operation. The school even named its sports teams "The Bombers".

The federal government has become interested in using ethanol as a replacement for imported oil and it subsidizes ethanol productions in several ways. At first glance, many people applaud the idea of using ethanol to reduce oil imports. Ethanol plants do not make sense to everyone, however. Much of our arable land is found in the Midwest. Recently, protests have begun to keep such plants from being built in several Midwestern states. In Cambria, Wisconsin, sides have been chosen. Not surprisingly, the Chamber of Commerce and farmers support construction of an ethanol plant by a local corn processor but most long-time residents do not. Those in favor see it as a way to bring jobs to the town and ensure demand for corn. Those opposed worry about air pollution, heavy truck traffic and depletion of the water supply. They are also concerned that existing environmental issues at the corn milling operation do not bode well for the company’s ability to handle a new and much more complex ethanol plant. A recent article in the (2007) Wall Street Journal offers a detailed report on this story and related issues. Let us know if you’d like to read it.

What position shall we take in a situation like this? Should small towns embrace power plants for the potential benefits they bring or should they oppose them out of fear of catastrophe, potential inconvenience or environmental concerns? Should they be compensated in some way for allowing plant construction?

There are no quick and easy answers to questions like these. They require study and time for serious consideration – a tall order in our high speed world – but they are too important to be dismissed in a rush to judgment.

A Ton of Feathers

Which weighs more, the grade school joke goes, a ton of lead or a ton of feathers? With gasoline prices hovering around $4 per gallon, a more appropriate question might be which costs more, a gallon of gas or a gallon of water? When I was in the manufacturing world, I followed the general rule that water needed for our dyeing/finishing processes cost a penny per gallon. Depending on the type of water you are interested in or what it’s mixed with, today’s answer might be a bit different. Here are some recent (approximate) costs per gallon for water and other water-based liquids:

1 gallon of tap water	$0.04
1 gallon of diet soda (warm 12 packs in a grocery)	$3.75
1 gallon of unleaded regular gasoline	$3.99
1 gallon of diet soda (cold cans from a vending machine)	$9.00
1 gallon of Starbucks coffee (grande cups)	$14.80
1 gallon of Evian water (9 oz bottles)	$21.00
1 gallon of Scope mouthwash	$85.00

You probably noticed that I slipped a non-water entry onto the list. I didn’t compile this list to embarrass bottled water drinkers or provide an alibi for the gasoline companies. I just wanted a simple way to put the prices of several commonly purchased liquids into perspective.

Among followers of the automotive industry, Toyota has rarely been caught making a misstep. However, its decision to enter the large SUV market several years ago has hurt the company recently. As higher gas prices have sent truck sales plunging for Toyota, right along with Ford, GM & Chrysler. Honda, which might have appeared off track in its decision not to join the truck-based SUV fray now looks prescient as it adds capacity to build its economical Civic sedans in southeastern Indiana. It typically takes more than three years to bring an automobile plant on line. Three years is also the minimum time required to re-tool and update the design of a car. These long lead times require considerable forethought on the part of auto makers who must do their best to anticipate consumer wishes, and thus required production capacity, far into the future.

As complex a decision matrix as those manufacturers face, gasoline producers have even longer lead times and an even more convoluted market for which to plan. While drilling a new well in an area where current wells are producing might be completed in as little as a year, drilling in an area where oil is thought to be takes much longer. In addition, most of the "easy" oil fields have already been tapped so any new domestic well is likely to be located in deep water or a very cold climate. A new refinery takes at least ten years to bring on stream and not every refinery can produce every type of gasoline necessary for the US market, let alone the whole world.

For example, the city of Chicago is large enough to enforce its own pollution standards. Even though Michigan City, Indiana, lives very much in the Windy City’s orbit, extra gasoline available there cannot be diverted legally to meet a shortfall in Chicago due to those differing regulations. With at least fifteen different formulations required around our country, deciding when to switch refinery production from one blend to another is a difficult task with a significant financial penalty for making a mistake. An oil refinery or automobile factory could easily require an investment of a hundred million dollars or more. That’s an amount not to be spent lightly, no matter how large the company. The more predictability our economy offers, the easier the planning process is going to be for these critical suppliers.

I have never been one to insist on my own way if some sort of compromise seems possible. I was, of course, distressed by the oil spill from the Exxon Valdez but I also believe that importing the majority of the oil required to fuel our cars is not in the best interests of our country. In this campaign season, may I humbly suggest that "single issue" voting and the staking-out of extreme positions is not the best way to provide the most good for the most US citizens? With the two contenders seeming (in mid-July, anyway) to be moving towards the "center", perhaps we can look forward to a highly productive first term for our new President.

The Politics of Sound Bites

The Politics of Sound Bites The popular TV series The West Wing provided a fictional glimpse into the day-to-day operations of the White House and the lives of the people who worked there. In one episode, during President Bartlett’s final debate, his opponent responded to a question with a “ten word answer”. Bartlett countered, “There it is. The ten word answer my staff has been searching for. But what I want to know is what are the next ten words and the ten words after that.” He concludes the debate by saying that he is the leader of “a country that’s way too big for ten words”.

We all need information but don’t always have time to search-out complete answers for ourselves. We have come to depend on TV and other sources for “ten word answers”, also known as “sound bites”, to fill in the blanks. Although sound bites can be quite useful in our multitasking culture, they have very real limitations. Like all shortcuts, they are incomplete, requiring that some details be truncated, glossed over or simply ignored. While they can be effective in making a point, people shouldn’t assume that sound bites tell the whole story.

Last fall, Speaker of the House Nancy Pelosi provided a “fourteen word answer” regarding gas prices, stating that “oil companies had unfairly earned record profits by gouging consumers at the gasoline pump”. I know that I can be overly quick to assume that capitalism works reliably and that price issues will sort themselves out through the actions of the marketplace. However, the fact is that taxes represent a larger percentage of retail gasoline prices than do oil company profits – taxes imposed by Representative Pelosi and other politicians at various levels of government.

The May 2007 issue of Wired magazine featured a map of the world showing the price of a gallon of gasoline in numerous countries. Comparative information about global gas prices can only be given via a “snapshot”, since most of the world purchases its gasoline in other than gallon increments and the value of our dollar fluctuates constantly versus almost every other currency in the world. At the time of the article, prices ranged from $6.65 per gallon in London to 33¢ in Tehran, with New York at $2.76 and Chicago at $2.69. Here’s a link to the original map for those who’d like to see what prices consumers in some other countries are payiying.

Wired Article

The map makes it clear that there’s a significant disparity in gasoline prices around the world. I believe that two basic factors govern retail prices: the cost of crude oil and local politics. Obviously, there is a direct relationship between crude oil and gasoline prices. However, energy costs and politics are also inextricably linked. If there is a political reason to keep prices low, some portion of the costs will be subsidized in order to increase the popularity of the seated government (viz Tehran). On the other hand, if political will leans towards reducing consumption, additional taxes can be assessed (viz London).

Award-winning columnist Robert Samuelson wrote an article titled The Politics of Symbolism for the January 22, 2007 issue of “Newsweek”. In it, Samuelson says: “Both parties have marketed government as a source of aid and comfort. Benefits are to be pursued, burdens shifted and choices avoided”. This seems an apt description of what usually happens when politicians engage in discourse regarding gasoline prices. As former President Ronald Reagan remarked: "It has been said that politics is the second oldest profession. I have learned that it bears a striking resemblance to the first."

I cannot very well stand up and debate Ms. Pelosi on the fairness of oil company profits. I can say that without oil company profits, there would be no capital available to locate new sources of energy, nor would the oil companies be able to pay the dividends on which their retired employees (and numerous other retirees) depend. Creating national energy policy is a complex task. It deserves serious discussion and full revelation of the facts, not oversimplification via sound bite.

All That and a Tank of Gas

As US residents, we are part of the world’s most vibrant economy. That can make it easy to forget that there is a very big world beyond our borders and not every country’s economy operates like ours. Neither, of course, do their political systems. Over the years, I have learned that politics and economics are usually intertwined and recent increases in gasoline prices have brought the politics of gas pricing back to mind. While our government taxes gasoline, other governments tax it more highly while still others choose to subsidize it instead.

It is obvious that gasoline prices fluctuate, although perhaps less obvious why. I continue to believe that the primary factor driving price changes is supply and demand but the fact that crude oil is valued in a currency which has been weakening for years (the US dollar) has certainly had an impact. I have heard it said that recent price increases have been caused by additional speculators in the markets but since those individuals deal only in paper contracts, never actually taking delivery of oil, it doesn’t seem likely that additional trading activity would be the underlying issue.

Regardless of the world price for crude oil, citizens of different countries pay different prices at the pump. Here is a chart reprinted from the May 29th 2008 issue of the British magazine The Economist(click to enlarge).It shows gasoline prices per liter in US dollars, adjusted for relative currency value. As you can see, the price we pay falls about halfway between the highly taxed German drivers and the heavily subsidized Venezuelan drivers. You can also see that Mexico falls below us, at around 60¢ per liter, compared to $1.04 per liter in the United States.

It’s always foolish to discount the ingenuity of our fellow citizens, especially when it comes to locating a good deal. While MSN compiles daily gasoline price information for the entire country, some Texas and California residents have another option available – driving across the border and getting a fill-up in Mexico. For political reasons, the Mexican government has chosen to keep gas prices low in the poorer farming areas in the northern part of the country. Since US citizens can travel back and forth without any special paperwork, filling-up south of the border has become popular. This has led to a boom in the business of installing of supplemental fuel tanks in trucks, which in-turn increases the number of gallons bought by US citizens. Mexico’s subsidies cost over $20 billion per year and I suspect various government ministries are reviewing their options very carefully right now.

As you look around, you probably see that Americans have begun to take conservation more seriously, driving more fuel efficient cars and even canceling vacation trips. Yet Chinese consumers, members of the world’s fastest growing economy, have a smaller incentive to do the same in their headlong rush to join the First World. According to The Economist, they pay less for fuel than we do.

Every component of the oil-to-gasoline "pipeline" is expensive. Increasing capacity for drilling it, transporting it over land and across the sea and refining it into useable form all require significant outlays in both time and money. In deference to the potential risk to our environment, no oil can be drilled in various portions of Alaska and the Gulf of Mexico. If Congress were to change its mind and allow drilling, for example in the ANWR, it has been estimated that it would be ten years before new fields were producing and a new pipeline available to transport that oil to refineries. In May, Congress passed legislation which halted the systematic purchases of oil for our Strategic Petroleum Reserve. Unfortunately, such politically motivated changes have little effect on the market. After having been endlessly debated and widely publicized, the impact of the halt in purchases has long been factored into the price of crude oil. Unlikely as its implementation might be, the appointment of an "oil czar", empowered to make day-by-day decisions about governmental purchases, would probably have been a more useful strategy in helping control oil prices.

An energy shortage serves no one, not even energy producers. Only a couple of countries are in a position to quickly increase the flow of oil. If they should do so, or if the Chinese build-up of fuel stocks ahead of the Olympics should abate and reduce demand, prices will probably fall again. The issue before the citizens of our vibrant economy will then be to decide if we have the political will to address our long-term energy needs systematically, rather than ignoring the issue until it once again looms large.