Consulting by RPM || Free Advice Blog

Long Lines at the Gas Pump?!

My wife just called to tell me that she saw gas prices well over $4, when just a few days ago they had been around $3.60 here. This isn’t surprising; Hurricane Ike is knocking out refiners and causing prices to skyrocket, despite lower prices for crude.

What troubled me, though, was that my wife said there was a long line at Costco (where she goes to fill up the SUV). This bothered me because my free market Jedi training told me lines at the pump were caused by price controls, not Arabs or hurricanes.

However, all was well with the universe when she got to the pump and said, “Wow! With the Costco discount the prices here are only $3.80.”

Markets still work, apparently. (This is good, since I woke up with a headache today and didn’t feel like dealing with cognitive dissonance.) Though to quote T. Boone Pickens, “I say drill drill drill.” (That is where I will stop the quoting from T. Boone Pickens.)

Faith in Climate Models Is Non-Falsifiable

Suppose you supported the global climate models touted by the IPCC, and because of this you also supported giving the government power to implement trillions in new taxes. But then, a new model came out that showed a regional impact was the exact opposite of what the global model predicted. Specifically, the global model predicted water shortages in the Middle East, but the regional model instead predicted rainfall increases of 50%.

I’m not sure what I would do, but I don’t think I would say, “The best science is confirmed by replication, and these models (and data used for input and confirmation!) are working in the right direction.”

People who put faith in these climate models are not subjecting that faith itself to scientific scrutiny. They are assuming that “We need to base policy on the best available evidence” (which is a tautology) but then leap to, “We need to base policy on the best available models.” The latter does not follow. Surely governments in the Middle Ages shouldn’t have enacted policies on the basis of the best climate models of the day.

Now my observation above doesn’t by itself prove that governments should never listen to climate modelers; maybe at some point their advice becomes useful. I personally don’t think we’re there yet. However, my view of whether we’ve crossed the threshold isn’t relevant to this post. Rather, I am just pointing out that very few proponents of the IPCC set up an independent benchmark for validity* and then test whether the current crop of climate models gets over that objective bar. Instead they usually give a smart alecky answer like, “Well if we wait for certainty we’d never do anything! ‘Oooh, how do I really know the sun warms the planet?’ Take a hike, Mr. Know-Nothing.”

* And note that I am saying validity for use as a policy input. Of course you can independently measure how close the predictions are to observed temperatures. But the real question is, “Are we confident enough in these models that we are going to completely revamp the tax code based on them, or delay the electrification of Africa based on them, … ?”

Big Alma Engages in Crimes Against Humanity

The industry-funded and non-peer-reviewed Old Farmers Almanac does its part to spread vicious lies about the scientific consensus on manmade global warming. NASA’s James Hansen is reportedly seeking counsel to bring suit. (HT2EE)

Murphy vs. Masters, Part Deux?

Masters Capital Management is back to their ways, picking on the hapless speculators. Does your heart go out to them, as does mine? I still have to read their new report, but I am skeptical.

In the meantime, on page 15 here (pdf) you can see the Sept. 5 issue of the Sacramento Union where I tackle the speculation issue. However, if you’ve already read my past articles on speculation, you will probably prefer to do the adjacent NYT crossword puzzle. I try to cater to all readers.

Don’t Tax the Poor Oil Companies!

I’ve been lightly blogging lately because the Bat Signal flashed and I had to fly to DC to participate in a Hill briefing. IER has just released a new study gauging the possible impacts of repealing the Section 199 tax deduction on major oil and gas companies. (This is part of the “revenue offsets”–I think that means “tax hike”–to pay for the $84 billion in goodies in the Gang of 10 [16] plan.)

Incidentally, on the way to the airport I somehow left my cell phone in the cab. Those who know me should be shocked; I truly border on OCD when I fly. (E.g. after going through security I quite possibly check 3 times per hour that I still have my license on me.)

Fortunately, I had tipped the guy fairly well, and when I got back “home” (actually to my parents to pick up my son) I used their cell to call mine. The cabbie answered, and I said I would mail him a SASE so he could pop my phone in a mailbox.

Question: I want to give him something “for the effort,” as Bill Murray would say. Yet a $5 bill seems crass. I’m thinking of a gift card to Starbucks. Is that too metrosexual (not that there’s anything wrong with that)?

CBO Releases New Deficit Forecast

On Tuesday the Congressional Budget Office (CBO) released its revised projections of the federal budget; check out this summary table (pdf). Highlights:

* The estimated deficit for the fiscal year ending September 30 is $407 billion.

* Under the baseline assumptions, the projected deficit for the fiscal year running from October 1, 2008 through September 30, 2009, is $438 billion.

* If Congress adjusts the Alternative Minimum Tax (as it probably will) in order to postpone a huge hit to the middle class, the FY 2009 deficit could be up to $82 billion higher, putting it at a record level exceeding $500 billion. Let me put that in other words: If Congress doesn’t allow the default $82 billion tax hike on middle class taxpayers to occur, then next year’s federal deficit will be more than half a trillion dollars. Remember, this is one year’s excess of spending over revenues, and this is all on-budget stuff. I’m not referring to hidden liabilities with entitlements or anything fancy like that.

* The above figures from the CBO only reckon that the recent takeover of Fannie Mae and Freddie Mac will cost the government $20 billion in FY 2009. If the housing market continues to slide, that number could mushroom. (Fannie and Freddie reported combined losses of $11.7 billion from 4q 2007 through 2q 2008.)

Things are getting a bit out of hand. As I have been harping on recently, it’s a darn good thing we didn’t get big government, big spending liberals like John Kerry in there. And if you still think John McCain is going to maintain the Bush tax cuts, well, you must not know the difference between a pit bull and a hockey mom.

Pickens Plan Too Cotton-Pickin Expensive

Below is a back-of-the-envelope calculation of the upfront cost of the Pickens Plan. To demonstrate that it is outrageously expensive, even on its own terms, I show how much cheaper it would be for the government to expand the Strategic Petroleum Reserve in order to provide comparable protection from foreign surprises. It should go without saying that I am not endorsing an SPR expansion, I’m just showing that it would be a lot cheaper than covering the US with windfarms and converting the transportation fleet to natural gas.

T. Boone Pickens has launched a major media blitz promoting his “Pickens Plan” to expand wind power for electricity generation, freeing up America’s natural gas to be used in the transportation sector. Both in his radio ads and recent letter to the Wall Street Journal, Pickens emphasizes that his plan “buys us the one thing money can’t–time.” The idea is that it will take decades to completely wean ourselves from our “addiction” to foreign oil, and in the meantime the Pickens Plan is to serve as a bridge during our remaining years of vulnerability.

As with several other components of his bold plan, Pickens’ ideas on “buying time” are flawed. In fact, with enough taxpayer money–and Pickens’ plan certainly requires plenty of that–you can indeed “buy time,” by expanding stockpiles of crude oil. The ostensible purpose of the Pickens Plan is to reduce U.S. vulnerability to a sudden oil import disruption, during the decades that we transition to complete energy self-sufficiency (presumably through hybrid cars, biofuels, etc.). Yet an alternative way to protect the country against sudden disruptions in oil imports, is to expand the Strategic Petroleum Reserve (SPR). In this short analysis, we will show that back-of-the-envelope calculations indicate SPR expansion would be a far cheaper way to “buy time” than the Pickens Plan.

What the Pickens Plan Achieves, and What It Costs

When one analyzes the specifics, the Pickens Plan actually doesn’t promise that much. In its concluding section, the plan states: “Building new wind generation facilities and better utilizing our natural gas resources can replace more than one-third of our foreign oil imports in 10 years.” This is an important point: The Pickens Plan does nothing in the beginning years; its “bridge” has to first be built. Remember that the plan calls for “[b]uilding wind facilities in the corridor that stretches from the Texas panhandle to North Dakota [to] produce 20% of the electricity for the United States.” But this isn’t all that is required for Pickens’ “bridge” to be ready. The purpose of this massive investment in wind-powered electricity generation, is to free up domestic natural gas supplies to fuel the nation’s vehicles. Thus, the U.S. fleet needs to be converted to handle natural gas, and the nation’s gasoline stations must be adapted as well. This is why it will take ten years before the Pickens Plan reduces foreign oil imports, and even then, only one-third of them. Now let’s get a rough idea of the costs of building this bridge.

The initial outlays for the plan are astronomical. Pickens himself admits: “Building wind facilities in the corridor that stretches from the Texas panhandle to North Dakota [comes] at a cost of $1 trillion. It would take another $200 billion to build the capacity to transmit that energy to cities and towns.”

The initial transition costs for the other component of his plan–namely, converting the motor vehicle fleet to run on natural gas instead of gasoline–are also enormous, and unfortunately Pickens here gives us no estimates. We can get some idea by comparing the prices of the NG Honda Civic–touted by the Pickens Plan–versus conventional models. The NG version sells for $24,590, while the Civic Si sells for $21,310, and the low-frills Civic costs only $15,010. According to emails with EIA staff, converting existing light duty vehicles to run on natural gas can cost anywhere from $6,000 to $20,000, while converting heavy trucks can cost between $20,000 and $50,000 per vehicle.

Relying on round numbers based on Wikipedia, for the present crude calculation we will conservatively assume that the Pickens Plan will require the conversion (or replacement with new models) of 235 million cars and light trucks to natural gas, at an average cost of $10,000 each. We conservatively assume the Pickens Plan also requires the conversion of 2 million heavy trucks at an average cost of $30,000 each. All told, we estimate that the upfront cost of converting the U.S. fleet to run on natural gas will cost at least $2.4 trillion.

Pickens’ own estimate for the wind portion of his plan is an upfront cost of $1.2 trillion, and above we conservatively estimate an upfront cost of $2.4 trillion to convert the fleet to run on natural gas. If we further assume a cost of $400 billion for other infrastructure changes, especially including the conversion of the nation’s 170,000 retail service stations to deliver natural gas–only 0.5% currently have this capability–then the total UPFRONT cost of the Pickens Plan is $4 trillion.

An Alternate Approach: Expansion of the SPR

Rather than a massive construction of wind farms, and a complete retooling of the transportation sector, there is a much simpler way to achieve the same reduction in vulnerability to another oil embargo: expansion of the SPR. To be fair to the Pickens Plan, we will assume a catastrophic scenario of an OPEC embargo that lasts for an entire year. (The 1973-74 OPEC embargo lasted only five months.)

Recall that the Pickens Plan, far from completely protecting the U.S. from such an embargo, would only mitigate its impact; the plan would only reduce U.S. imports by one-third. So, in order to match the effective protection offered by the Pickens Plan against our hypothetical embargo, the SPR would have to contain an additional four months’ worth of net oil imports. With that additional cushion of four months’ worth of imports in the SPR, if and when a year-long embargo struck, the U.S. could reduce its imports (at that time) by one-third, by drawing down on the SPR. Thus the U.S. would only have to import two-thirds of its normal volume of foreign oil during the year-long embargo, which is the exact same position the country would be in under the Pickens Plan.

How much would it cost to expand the SPR to contain an additional four months’ worth of net oil imports? We can get some back-of-the-envelope estimates by looking at the existing SPR, which has a capacity of 727 million barrels. Based on historical figures from this CATO Policy Analysis (pdf), this 727-million-barrel-capacity required construction costs (in 2008 dollars) of about $10.3 billion.

How much additional capacity would be required, in order to provide a four-month additional buffer, starting in ten years (when the Pickens Plan would be ready)? According to the EIA reference case in its Annual Energy Outlook 2008, total U.S. oil imports in the year 2020 will be some 11 million barrels per day, meaning the U.S. would need to boost the current SPR capacity by about 200 percent, in order to add an additional four months’ worth of imports by the year 2020. Based on the figure above, construction of this additional capacity would cost in the neighborhood of $21 billion.

We must also include the cost of filling the expanded SPR with the extra 1.32 billion barrels of crude (the four months’ of imports). Fortunately, the government would have ten years in which to fill the new SPR facilities–that is the time it takes to put the Pickens Plan in place. Presumably the U.S. government would notify major oil producers of its intentions to make massive purchases, and could wait several years for them to expand their pumping capacity. This would make the price spike (due to the new SPR purchases) lower than without such warning and lead time. Even so, the world price of oil would surely be higher because of the program. The EIA currently projects prices in the years 2015 – 2020 in the low $50s (in 2006 dollars), so for the sake of argument we will suppose that the SPR purchases would occur at an average price of $55 per barrel (in 2008 dollars). That works out to $73 billion for the crude going into the expanded SPR. However, prices will be higher for all imported crude during this period. If the fill occurs over a 3-year window, and keeps world oil prices $5 higher than they otherwise would have been, that is an additional $60 billion in U.S. expenditures on crude imports that could arguably be included as part of the upfront cost of the SPR plan.

Counting the $21 billion construction costs of the new storage facilities, the $73 billion to purchase four months’ worth of crude imports, and the $60 billion in higher import expenditures during the fill period, the total upfront cost of the SPR expansion plan is $154 billion, which is less than 4 percent of the upfront cost of the Pickens Plan.

Conclusion

The above estimates are obviously quite rough, but they show that the Pickens Plan–even on its own terms–is an incredibly expensive way to guard against the possibility of future oil disruptions. An alternative plan of expanding the SPR would cost about 4 percent of the Pickens Plan to achieve the same degree of protection. Moreover, much of these (far lower) costs of the SPR plan could be recovered, in the event that a catastrophic oil embargo did not occur, from selling off the stockpiled crude reserves. Finally, we have so far only considered the initial costs to get the two rival systems operational. The annual maintenance costs–for stockpiling an extra billion-plus barrels of crude, on the one hand, versus operating a huge wind and natural gas infrastructure spread throughout the country that is more costly than the system it would replace–would be far higher under the Pickens Plan.

There are potential benefits of the Pickens Plan that we have ignored. For example, Pickens’ ultimate dream of national “energy independence” would presumably be easier to achieve after the $1.2 trillion are spent on building a corridor of wind power. We do not claim that our rough analysis includes all such considerations. However, it is clear that supporters of the Pickens Plan must put out far more detailed studies than the vague proposals they have thus far released. It currently appears that the plan would be an incredible boondoggle and would waste trillions of dollars.

Working Paper on Market Responses to Climate Change

Here is my working paper (pdf) on a a framework for understanding how a truly free market (the world over) would deal with dangerous global warming, if the IPCC consensus turns out to be right and humans really are responsible. This is an extension to my earlier op ed claim that cap & trade is not the “market solution” as advertised. I know some of my readers actually have real jobs, so below I reveal the paper’s conclusion.

Economists should deal with the theoretical case of catastrophic anthropogenic global warming, if only to better understand the operation of market mechanisms. However, the standard libertarian reliance on property rights enforcement as a solution to pollution, should not be construed as an endorsement of cap and trade as a “market solution.” It is unlikely that a decentralized, market-based legal order would produce separate property titles in greenhouse gas emissions, in order to deal with large negative externalities that are caused by the majority of humans and also impact the entire planet cumulatively. Consequently, under the current system of government monopoly on legal rules and enforcement, if politicians decide to pick a number of tons of carbon that can be legally emitted each year, that approach can at best be described as market socialism.