Below is a response from reader Earl Killian, who lives in Silicon Valley. Earl sent me an e-mail a couple of days ago in response to my August essay on Prop 87: California’s Proposition 87 It is getting close to election time, so this is a good time to revisit the issue. Besides the entry above, previous entries on Prop 87 are:More on California’s Proposition 87 Prop 87 Interview Addressing Proposition 87 Criticisms Breaking Down Prop 87 Another Khosla Critic Wow. I have written on that a lot more than I thought (although the 3rd link in the list is a pro-87 guest essay).Anyway, I thought Earl made some very good points in his e-mail, and instead of having his comments buried in a 2-month old post, he gave me permission to post it here. I disagree with his belief that it won’t raise prices, and I may briefly comment after the essay.———————————–
I came across your blog entry from mid-August about Prop 87. It seemed like a long time later to post a comment, so let me send an email. I can always post something if you tell me you would prefer that.First, I can certainly sympathize with your outrage at the way Prop 87’s proponents are selling the Yes vote (and equally with the opponents selling of the No vote). However, all California ballot propositions are like that unfortunately (I have ideas on how to fix ballot propositions, but that is another matter altogether).My big concern with what you wrote is your statements about price increase. It seems that you are missing a key item. The refineries will not pay any more for their crude, and so there will be no price increase to pass onto the consumers. The oil field operator will feel the pinch, not refiners like Chevron, etc. The oil field operator has to compete with imported crude oil, and so he cannot raise his price; the refinery would be happy to buy crude from Iran or Russia if they save $0.01 per barrel (of course certain refineries are set up to process certain kinds of crude, and cannot switch as easily, but I think they still have alternatives). All of the economists I’ve heard seem to agree on this point, by the way.In reality this is unfortunate. A price increase at the pump would be a better tax exactly because it would actually increase gasoline prices. Increased gasoline prices would do as much to spur innovation as state funded research. Still, I believe the authors of this initiative went for an oil field tax precisely because they wanted to be able to say that gasoline prices would not rise (i.e. clever politics, not good policy).I am also surprised with the degree to which Prop 87 is seen as an ethanol measure. Sure, ethanol will get funded, but with many other things as well. Like you I think Khosla is wrong, and ethanol will fail. However, let’s say biodiesel from algae (which really looks quite promising) succeeds. Ethanol will be a dusty footnote.The state of California actually has decent track record at making significant progress on things like this. Let’s take another effort from the distant past (mid 1970s) as an example. Please download http://tinyurl.com/y5el2l and look at page 14 and compare the yellow line (California) to the purple line (what we would have if not for our state government’s efforts). It indicates all too well the problem of having a red white house.The graph may seem abstract and not very significant, but the difference is HUGE. There is a gigaton of CO2 per year hidden between two lines of that graph. Just bringing the U.S. per capita kWh of 11,997 down to the California level of 6,732 would cut U.S. greenhouse gas emissions (from all sources, including transportation) by at least 17% (as much as 30-some percent if we used the saving to selectively close coal power plants). Were the U.S. to get to California’s level, we’re talking about nearly one gigaton of CO2 per year that would not be fouling Earth’s atmosphere.Said another way, had California not been a leader, the U.S. would be emitting some sizable fraction of a gigaton CO2 more than it does today (add up the population of just California and New York–which followed California’s lead–and you get 18% of the U.S. population). (See http://tinyurl.com/zfehv for state rankings in per capita kWh use.)I have looked over the text of Prop 87. Like every other ballot initiative I’ve ever read, it stinks. Still, I have voted for a number of stinky propositions because they are better than the alternative. I think Prop 87 falls in this category.Again, I agree with you that corn ethanol is not the answer. Where I differ is that I don’t think Prop 87 is all about ethanol. Sure, some ethanol efforts will get funded as a result, but so will some things that might make as much of a difference as what California did from the mid 1970s onward to lead the nation in electric efficiency. Prop 87 will have a nine-member commission appointed by various interests. Even if Vinod Khosla is one of the nine, I doubt a group of diverse individuals will swallow the ethanol-only pill (now would that be a blue pill?).The California Energy Commission did an OK job on keeping kWh per Californian down. I think the “bureaucracy” should be commended, not condemned for that. (There’s plenty of waste still to complain about, but it would have been even worse without the CEC’s efforts.)
-Earl
OK, just one real disagreement with Earl’s post:
The oil field operator will feel the pinch, not refiners like Chevron, etc. The oil field operator has to compete with imported crude oil, and so he cannot raise his price; the refinery would be happy to buy crude from Iran or Russia if they save $0.01 per barrel…
What you write is true, but incomplete. There are a number of marginal producers that start to come online as oil prices get higher and higher. This is always the case, and it increases competition for rigs and drives up costs. So what Prop 87 is going to do is change the point at which those marginal producers start to shut down. This will lead producers to turn to other, more expensive options, and will increase the imports into California. I have gone on the record predicting that this proposition will open up at least an additional $0.05/gallon gap between California and the rest of the country. But I will also predict that you will see a change in the slope of California’s oil production curve next year. California is in decline, so the curve is headed down, but I think it will take a sharper turn down next year as some marginal producers shut down.
All of the economists I’ve heard seem to agree on this point, by the way.
A great number of economists have come out and said the proposition will absolutely raise prices. I can give you a number of links later if you like. Many California newspapers have editorialized against Prop 87, and The Wall Street Journal also weighed in this week. Some excerpts:
California’s Bottomless Tax Well
October 23, 2006
Proposition 87 would raise taxes on oil extracted from California by 1.5% to 6%, depending on the price per barrel — all in the name of reducing energy consumption and
dependency on foreign oil. Let us run that by you again: The idea here is to tax California oil in order to get Californians to use less Saudi oil. Brilliant.
If approved, the law would raise costs on California’s oil producers by as much as $4 billion over the next 10 years. California would overnight become the state with the highest tax on oil producers in the U.S. — which makes as much sense as Vermont levying the highest tax on maple syrup. Not one penny, by the way, would go to close Sacramento’s enormous government debt burden — which may rise by another $40
billion if the multitude of bond initiatives for new public spending are also approved by voters this November.
A Law and Economic Consulting Group (LECG) analysis concludes the bill would in fact increase dependency on foreign oil because the tax increases the price only on domestic oil. Meanwhile, to make it seem as if the tax will be paid by “greedy” energy companies rather than voters, Proposition 87 would make it illegal for producers to pass on the tax costs to consumers. But wait. The “Yes on 87” lobby also claims that the law would reduce California oil consumption by 25%. How does a law that doesn’t allow the retail price to rise reduce gasoline consumption? These are logical niceties that no one much cares about when fads are in season — and taxing energy is the biggest fad of them
all these days.
The biggest impact of Proposition 87 would be to make California oil relatively more expensive to produce than Saudi, or Venezuelan, or Canadian oil. So if 87 passes, Californians will be approving the equivalent of a tariff on their own oil. So the tax would actually make America slightly more, not less, dependent on foreign oil. This is an
energy plan that only Venezuelan strongman Hugo Chavez could love.
Now, having said all of that, I stick with my prediction that it will pass. I know support has fallen while gas prices have come down, but the oil majors are all releasing earnings reports just in time for the election. I think people are going to vote to punish oil companies by voting for this measure, but I also predict they will ultimately regret it.
Cheers,
RR
Your analysis is correct, prices will inevitably climb if you limit supply, because it’s a world-wide market and refiners will have to buy supply from the rest of the world to make up any shortfall in domestic production. Geoff Styles (“Energy Outlook”) offers a similar opinion. Ultimately, you can only reduce demand by allowing prices paid by consumers to rise. Proponents of alternate energy lack the courage to put it to us (the voters) straight. Given a chance to vote to pay more for fuel in exchange for funding some energy alternatives, I would certainly vote “yes”.
What you say is probably true, that a crude extraction tax will push some marginal operators out of production sooner than they otherwise would. However, because crude is a global commodity, this has to be measured against global production. A decrease in California oil will cause world prices to rise slightly, which will increase the price in California, but also in New York and Tokyo. In 2004, California produced 240M barrels, while total world production was 26360M barrels. So California is 0.9% of the world production. Let’s say that no more than 10% of California producers stop producing because of the tax; that caps the world production loss at 0.1%, which is likely to have an effect, but a pretty small one. Again, Prop 87 is a tax that affects world prices, not California ones. Of course if the research succeeds (that is finds alternatives that are used by people) then Prop 87 likewise affects gasoline prices by reducing demand, but again the reduction would be in world gasoline prices, not California prices.
A decrease in California oil will cause world prices to rise slightly, which will increase the price in California, but also in New York and Tokyo.
That presumes perfectly smooth, efficient, and instantaneous markets. Oil and gas prices right now vary greatly from region to region even in the U.S. Ask yourself why that should be.
There was a major refinery outage in St. Louis earlier this year. Gasoline prices shot up quickly. Of course this should have caused gas prices in Tokyo to shoot up as well, if we accept your premise. But in fact, it didn’t even affect prices outside a few hundred mile radius of St. Louis, even though the outage lasted over a week.
Cheers, Robert
I agree that short-term prices will increase locally in response to a local decrease in supply. I think I remember estimates that it takes 6 weeks for global supply to affect local (e.g. the time to reroute oil tankers). I simply made the assumption that we were interested in long-term prices with Prop 87.
I would like to point out how lame the public discussion on Prop 87 is. I think the editorial Robert quoted is a perfect example.
One of the few pieces of data in the editorial was this: “Proposition 87 would raise taxes on oil extracted from California by 1.5% to 6%”.
Other than that, it was almost content free. (This was restated later using the $4B figure, instead of a percentage.)
Mostly the editorial employed rhetorical devices in an effort to trick readers. For example, “The idea here is to tax California oil in order to get Californians to use less Saudi oil. Brilliant.” This is an example of claiming something about ones opponent’s argument, and then knocking it down to score points, but if that wasn’t really the opponent’s argument, all you’ve done is mislead.
In the next one, the editorialist argues only that she doesn’t see something. Is that definitive? Partisans fail to see things they don’t want to see all the time. “Proposition 87 would make it illegal for producers to pass on the tax costs to consumers. But wait. The Yes on 87 lobby also claims that the law would reduce California oil consumption by 25%. How does a law that doesn’t allow the retail price to rise reduce gasoline consumption?” Of course the editorialist is ignoring the intended path to reduced oil consumption, i.e. switching Californians and others to alternatives such as renewables. Convenient for her, because then she doesn’t have to address the real issue, only a scarecrow. The same thing happens in the next paragraph of the editorial.
If you analyze the WSJ editorial in detail, you see it is mostly not taking anything head-on, not informing, but simply trying to amuse with pretty references to maple syrup, Chavez, taxation fads, and Saudi oil. If this is the level of serious public discourse, we are in real trouble. (Actually, almost all of the WSJ people have quoted to me are like this. If only their editorial page had the same high standards as their news pages.)
Earl, I will let you have the last word with respect to price increases. As I stated earlier, I think this is the only real area of disagreement that we have, and we could debate this issue for several more rounds.
I did see yesterday that Chevron had released profits:
Oil giant Chevron’s 3Q profit hits a record $5 billion
The touched on one that that really annoys me about the campaign being run by Prop 87 proponents:
With earnings so huge, oil companies would like to make sure we consider their profit margins. In Chevron’s case, its profit for the latest quarter was just over 9 percent of its revenue; Google, by contrast, had a profit that was more than 27 percent of its revenue, according to the Associated Press.
I just had an essay published at Venture Beat in which I discuss the hypocrisy here:
Prop 87: Deceptively marketed
To me it’s very hypocritical that a venture capitalist who made his fortune in a high margin business is critical of oil company profits.
Cheers, Robert
Robert Rapier wrote:
Earl, I will let you have the last word with respect to price increases. As I stated earlier, I think this is the only real area of disagreement that we have, and we could debate this issue for several more rounds.
Thanks for the last word, but of course I’m possibly missing out on the chance to learn something if you don’t counter with additional information, if that information is deciding. The purpose of debate is both to teach and to learn. It is why I am so upset by things like the WSJ editorial, since teaching and learning are so remote from it. (It is more like a “feel good” piece their choir.) I am not replying simply to “win”, but rather to get to the truth of the matter (and since I could be overlooking something, debate might actually expose that).
If the point is that oil prices do vary with geography, I believe that. But if you factor out the transportation costs, regulatory requriements, and the difference in crude grade (“light sweet” vs. “heavy” etc.), are there still significant differences?
I also think you have to separate out gasoline from crude in this discussion. Gasoline is less fungible than crude, and so more sensitive to locality. For example, the California blend is not the same as the Texas blend of gasoline (and refineries cannot switch effortlessly), and of course state taxes vary (as you’ve pointed out before). Also, gasoline distribution infrastructure tends to be more locally oriented than crude (tanker trucks vs. supertankers). That limits the ability of Texas refineries to supply California, for example. (Not that these things don’t happen in certain circumstances.)
We should also be worried about binary thinking (unfortunately our language encourages it). The real question is not whether Prop 87 has a zero price effect or not, but whether its effect is small or large (i.e. close to the 1.5% to 6% hinted by the WSJ). Unfortunately I think its effect will be quite small in the medium term (4 to 10 years?). Long term it might decrease prices, if the funded research is successful (hard to predict that).
Prop 87: Deceptively marketed
I read the above and I have no issues with the points about profit margins and so forth. However, the arguments by proponents and opponents of a measure, however deceptive, are not the issue. If it were, no one could vote for any side on almost any issue, since there are too many deceptions on every side.
I have a question for Earl, can you point me to the law(s) that led to the effort started in the 1970s? I read the slides; however, I question if 87 can accomplish as much because of its lack of concrete public policy.
For example, the recent Global Warming Bill (AB 32), requires standards for businesses to reduce their emissions and to allow them to trade CO2 emissions credits on the free market (a similar cap-and-trade market process for other harmful emissions). This bill follows a model that has worked in the past and addresses the issues at hand much more directly. I question if Prop 87 has enough meat to get results.
I am skeptical of the prop because of 1) its exemption from special interest laws — is this better for private research firms, or for us? and 2) the inflexibility of funding other technologies outside of the proposition’s language. “Funds could not be shifted if, for example, research identified a new technology that would more effectively reduce petroleum use but that technology does not meet the specifications contained in the measure”, reference from http://www.cbp.org/pdfs/2006/0609_bb_prop87.pdf.
I stongly believe in investing in clean energy research, but I doubt that this proposition will put the $4 billion in the right place. I’m still debating which way to vote on this, so any input is appreciated.
Thanks.