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10/15/2005

Conserve now or pay later: Q & A with Kenneth Medlock

With prices having eased slightly, consumers should continue to curtail their consumption of all fossil fuels. With predictions that the demand for heating oil and natural gas is likely to outpace our supply, winter heating costs could double or triple relative to recent years, warns energy economist Kenneth Medlock at Rice's Baker Institute for Public Policy.

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Q. What are the current and future consequences of Hurricanes Katrina and Rita in terms of U.S. energy supplies, distribution and prices?

A. For the time being, the impact of Hurricanes Katrina and Rita on our supply of crude oil has been mitigated by a couple factors, one being the global nature of the crude oil market. Increasing imports will offset the reduction in crude oil supplies from the Gulf of Mexico due to the hurricane damage.   In addition, some of the supply problems will be offset by the release of some of this country's Strategic Petroleum Reserves.

However, the costs of fuels such as gasoline and heating oil, which are derived from crude oil, are rising as a result of diminished refining capacity and continued consumer demand.

America's refining capacity has been fairly tight, so when one refinery goes off-line for any extended period of time, it places a lot of pressure on the remaining refining capacity and creates tight commodity markets.

Longer term, it's not necessarily a simple matter of refineries coming back on-line and prices dropping to their former level. Right now, we need to utilize gasoline inventories in order to meet demand. Over time, as we deplete those inventories, the marginal value of the next unit of gasoline increases. Basically gasoline is becoming increasingly scarce, and as that happens, prices, of course, will continue to rise. Demand needs to be reduced relative to available supply to keep prices from rising further.

Natural gas markets were already growing increasingly tight due to strong growth in demand, particularly for power generation. The recent hurricanes have forced production shut-ins that cannot be offset by imports, which has exacerbated market tightness.   This has led to a significant increase in price.

Q. Is it realistic to think that a new refinery will be built at some point in the future?

A. While no new refineries have been constructed in the past 20 years, capacity has expanded. Refinery capacity has increased by about 10 percent in the last 20 years.

Given the regulatory hurdles companies would have to cross. I think the likelihood of a new refinery being built to meet increasing demands is pretty slim.

Q. What can consumers do?

A. Overall, they need to significantly curtail their energy consumption.

I think the effect of conservation is often under-appreciated. Between 1978 and 1990, we saw cars' average fuel efficiency increase from 12 to 20 miles-to-the-gallon. And even though we also saw increased driving activity, we actually saw a flat-to-slightly falling rate of gasoline consumption because of increased fuel efficiency.

Higher fuel efficiency is part of the reason we experienced such low gasoline prices for such an extended period of time.

In the last 10 to 15 years as people have begun buying bigger cars, we've seen a reduction in the average fuel efficiency for motor vehicles in this country.

As high as they may seem, current gasoline prices in real terms are actually less expensive than they were in 1982. Thus, consumers may not feel the need to significantly curtail their fuel consumption at this point. However, conservation efforts will become increasingly important as winter approaches, because heating oil and natural gas markets are likely to be very tight. Home heating bills, for example, are probably going to be two-to-three times higher than they have been in the past.   

Q. What should Congress and the President be doing?

A. Both our Congressional leaders and the President need to emphasize the critical importance of conservation.

While amendments to the recent energy bill regarding fuel efficiency have been proposed, more attention needs to be paid to the demand side of the issue.   I do not think the recent energy bill adequately addresses Corporate Average Fuel Economy (CAFE) standards.

One of the things we saw as a result of the post-oil price shocks that occurred in the 1970s was a heavy emphasis on vehicles' fuel efficiency. Currently, public policy and sentiment in this country views energy as a right rather than a commodity. Actions are taken, for example, to make sure that energy can be provided relatively cheaply to consumers. But, ultimately fossil fuels are depletable, and their costs will rise, not to mention the costs incurred to ensure stable supplies. In the long term, Congress and the President need to address permanent solutions to abate increases in energy consumption.

Q. Do increases in heating oil prices necessarily mean we also will see higher prices for natural gas?

A. To the extent that there is competition between heating oil and natural gas, which are substitutes for residential and commercial heating, their prices will chase each other.   For example, with a tight natural gas market and high prices, an increase in demand for heating oil should be expected, which will, in turn, cause the price of heating oil to rise.

In the next couples of years, the current constraints on natural gas supplies will be reduced because we will be importing more and more liquefied natural gas.   In fact, we will be relying increasingly on natural gas from overseas, much as we do now for oil.

Once new liquefied natural gas regasification facilities become operational along the Gulf coast, the price of natural gas will decrease.

Historically, the U.S. has gotten a large majority of its supply of natural gas from the Rocky Mountains, west Texas and the Gulf coast. Roughly 25 percent of this country's natural gas is produced in Texas and another 25percent in coastal areas along the Gulf of Mexico.   We also have been importing natural gas from Canada.

Because it is such a clean source of power generation, the demand for natural gas in this country has been growing. In the 1990s, natural gas averaged under $2.50 per-million BTUs. Today, it is trading closer to $15 per-million BTUs.

For more information on this research, contact Medlock at medlock@rice.edu or B.J. Almond in the Office of News and Media Relations at balmond@rice.edu.