2005-10-01

Inflation - the end of the world!!

I hope by the title of this article you would have detected my cynicism.

Yes, inflation has finally hit - at least here in Australia. A major milk supplier has announced a $0.16 per litre increase for milk. It's all over the news, and in Tasmania they're panic buying before the costs come into play on Monday. Why? Because the price of petrol/gasoline is finally raising the costs of certain goods and services.

I like to think of my fellow countrymen as being superior to all of those on planet earth when it comes to thinking and making decisions about things. Alas, this episode has confirmed yet again
the simple fact that Aussies are at least as stupid as anyone on this globe. At least.

This comes out in the responses of the Federal Government and the opposition to the current "crisis". The Federal Government is trying to point out that there's been some price gouging and profiteering going on. The Opposition is arguing for fuel tax cuts.

I've already posted on the reasons why petrol prices are so high. Eventually hikes of this magnitude would boost inflation.

So why is the government focusing so much on "price gouging" and "profiteering"? Well, for starters, it's actually a cynical way of diverting the issue. It's not actually the government's fault that prices have risen, but they can't exactly sit there say that to everyone so they feel the need to blame someone else - in this case, the oil companies.

I saw a graph shown by the government on tonight's news. It shows a rather large increase in the profit margin of oil companies since Katrina hit in Lousiana, and forced global gasoline prices to rise. I saw the graph and responded in the only way I knew how. I scoffed.

Of course the oil companies are increasing their profit margins. This is the normal way a market economy functions. Think about it - if you had your hands on a product that was in demand, but was getting scarce, wouldn't you want to increase your profit margins? The whole idea of a market economy is that goods and services are sold at the price they can be sold at. What's the point of selling something for $1.00 per litre when you can sell it for $1.35 per litre? The only reason why a person or company sells something at a certain price is because they can.

So worldwide supplies of petrol/gasoline becomes scarcer because of Hurricane Katrina hitting America. The product becomes scarce, so the oil companies make more money. That's just the way it is - we can't change it.

Think of what should happen if, in the middle of Australia, we discovered a source of Light Sweet Crude that is so refined that you could almost pump it directly into your car. And let's say that the quantity that is found is 20 times that known to exist in the Middle East. What do you think would happen? It would mean that the price of oil would crash, since there would be this enormous increase in quality oil coming (eventually) onto the market. Prices at the filling stations would drop. But you know what else would happen? Profit margins would collapse as well. Oil companies would go bankrupt - especially those whose extraction and refining costs are high. That's the down side.

So the reason why these oil companies are making lots of profit is because oil production is not meeting demand. For more of the reasons behind this, I suggest you peruse the Wikipedia article on Hubbert peak theory, where it explains the scientific reason behind declining oil production, and why oil prices are likely to continue going ever higher.

So that's the Australian Government put in its place. Now what about the opposition?

The Australian Labor Party (ALP) constantly amazes me in how dumb they are. If they weren't so dumb, they might be a viable alternative to the Liberal/National Coalition (the current Federal government). By the way, I don't vote for either.

Here in Australia, both the Federal and State governments have taxes on petrol. The ALP has called on the government to reduce these taxes. That is just not the point. Again their call is merely political, placing the blame for high petrol prices upon the government.

What is really needed is to conserve petrol, which means that we need to do away with our 4WDs and SUVs, V8 and V6 cars. We need cars with more fuel efficient engines. We also need to think long-term and work out alternative sources of energy. While I agree that such a priority requires direct government input, making petrol cost more via taxation is an indirect way that the government can force the marketplace to react.

All I'm saying is - keep petrol taxes. In fact, it would be good to increase them.

So what about inflation? What's going to happen? Are we due for another 1970s period? I think not.

Inflation in the 1970s was killed by monetary policy - the raising of interest rates. Everyone these days thinks that Allan Greenspan is one of history's greatest men. I think history will be very unkind to Mr G. I think, however, that history will be very kind to one Paul Volcker - the guy who preceded Greenspan. In a very short period of time, Volcker conducted some very painful economic surgery upon America in the late 70s. He raised interest rates and killed inflation. He also started a severe recession - but his actions were necessary.

So what is ahead of us? Higher interest rates. Even a recession. Not good news - but don't blame me when it happens.

Update:
I just read the following from the Sydney Morning Herald:

The federal government has delivered a blunt warning to businesses - do not use soaring fuel costs as an excuse to hike up prices on other goods and services.
Duh. The logic behind this is... well... there isn't any. If a business has increased costs, then what should they do? Should they just take it on the chin or should they begin passing on those costs to their customers? If they want to survive in business, they'll do the latter.

Moreover, the "business friendly" Liberal/National coalition is trying to deflect blame onto businesses. Not a good way to treat your core supporters.

All this proves that spin and media manipulation is what politics is all about - not truth.



From the Osostrian School Department

© 2005 Neil McKenzie Cameron, http://one-salient-oversight.blogspot.com/



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This work is licensed under a Creative Commons Attribution 2.5 License.

4 comments:

FatTriplet3 said...

OSO,

Thanks for reading my post and for pointing me to this link.

I really like your "light,sweet, crude" example. You are exactly right that, in such a scenario, the market price would fall below the price of production for most oil companies (and someone in Australia would get very, very rich!) and they would go bankrupt.

I do not subscribe to the Hubbert Peak Oil theory at all. Bad science and bad economics. For a good refutation of Hubbert's theory click here.

I also did an earlier post on why I don't worry about "running out of oil" which you can find here.

Lastly, about your comment about raising gasoline prices. It indeed would suppress demand but effects of taxation are insidious and far reaching. It doesn't just increase the demand for smaller more fuel efficient cars. It makes the economy less efficient and slows output.

Cheers,

Steve

One Salient Oversight said...

Steve,

I spent some time reading the article you linked to. It is not a very convincing argument for the following reasons:

1) The author appears to treat those who believe in Peak Oil as being "doom & gloomers". The language his uses about the theory is often derisive and dismissive. Therefore he doesn't really interact with the issue at all.

2) The author readily agrees that the "theory" doesn't match the evidence, but spends scant time examining why this is the case. Instead he links "Hubbert's Peak" with the "Phillip's Curve", as though a theory based on geoscience can easily be lumped with a theory based upon historical economics.

3) The author also fails to examine the actual science of the peak. He does not interact with scientific research in and around the subject of oil reservoir depletion.

Take it this way - Hubbert's peak is representative of the life of every oil reservoir in the world. America's oil production peaked in 1970... why? Because oil became harder and harder to extract from existing reservoirs. Hubbert's peak has been proved empirically.

Add to this the following points:

1) The Middle East has been extracting oil for decades. They are therefore approaching peak extraction (or have already reached it)
2) Since 1980, hardly any new oil fields have been discovered around the world that are big enough to make a sizeable increase in reserve capacity.
3) During times when oil supply was high and prices were cheap, suppliers could easily "turn off the tap" to restrict production. This has the effect of delaying the peak from occurring. Once the peak has been reached, however, the producers cannot simply "turn the tap up" to extract more oil. The tap will be fully open, but the flow will be increasingly weaker.

FatTriplet3 said...

OSO,
Are you willing to agree that pundits have been saying that we would run out of oil for 100 years and that they have always been wrong?
Steve

One Salient Oversight said...

Steve,

The simple answer is "Yes.. But"

Back in 1981 I was sitting in school when the teacher got some environmentalists to come to speak to us. They were very sincere, very interesting people, and they told us that the world will run out of oil in ten years.

When you're 12 years old, such things are a long-way off. But I did remember it. As a result, by the time I left school (1986) I had given up on the whole world-is-running-out-of-oil thinking.

So when a friend of mine emailed me last year and told me "The world is running out of oil", I had to respond. Nonsense I said. I had just got the latest Economist magazine, which showed that proven oil reserves in the middle east had about 70-100 years to go.

Nevertheless my friend my insistent. He tried to tell me all about Hubbert Peak and the science of it. I responded with economics, arguing that with 70-100 years of reserves in the ground there would surely be enough to pump out to meet demand for a long time.

In the end I decided to explore the issue myself. My friend gave me "The end of Surburbia" to watch, which I did and didn't find convincing.

One thing bothered me, though. I did a simple calculation. I found the amount of total proven international oil reserves and divided it by the 2003 international oil consumption figure. The number was slightly less than 40 - less than 40 years before we consumed the available oil.

Like my friend, I too did not believe that the 2003 consumption figure would remain static - it would increase as demand increased.

I then discovered that the figures of 70-100 years reserves were based upon the 2003 figures, and did not take into account increasing demand. That worried me even more.

Then I discovered that the sheer amount of new oil reserves discovered since 1980 was nothing compared to the oil discoveries before that. ie Discovery of oil supplies has not matched consumption.

Eventually though, it came down to one basic argument - how fast can oil be pumped out of the ground?

I used to think that oil reservoirs were like big caves underground filled up with oil, and all people did was tap them with a straw and suck it out. Wrong. The oil exists inside permeable rock. When a well is dug and the oil is extracted, it comes out under pressure. As more and more wells are dug, more and more oil comes out.

Eventually, though, the reservoir "Peaks". In other words, the rate of oil flow reaches a top speed, and then begins to drop again. Oil fields like this no longer have well heads, but "Nodding donkeys" that extract oil via a pump.

It is this phenomenon - a peaking of production from a well - that Hubbert's Peak is known for. It is an empirically provable scientific phenomenon. Take US oil production - it peaked around 1970/71, exactly the years that Hubbert himself predicted. Since then, US oil production has slowly dwindled to about 2/3 of that amount today. Why aren't all those Texas oilmen extracting more and more oil? Surely the price at the moment means it is black gold - but they can't get it out fast enough because the US oil reservoirs have peaked and are producing less and less oil every year.

The current idea at the moment is that the middle east is nearly at peak capacity. Their reservoirs are old and not many new sources of oil have been discovered.

You have to remember that Peak Oil is not "The world running out of oil". It is actually about supply not keeping up with demand - since supply is restricted by geology. And, as we know, when supply is unable to match demand, the price goes up.

Why do you think oil prices have been so high for the past 2 years? Speculation? Cheating by oil companies? Or maybe it is basic economics - the suppliers can't get it out to the market fast enough.