oil prices

As we watch the markets throughout the world plunge trying to find a trading range, we are witnessing the global market reset to economic fundamentals.  Before you think this is unambiguously bad (the reset) consider that this entire event spanning the last two to three years was set in motion by government policy actions and the flood of liquidity beginning after the September 11th attacks.  The market is simply correcting now what government policy actions have caused, a massive destruction of the mirage of paper wealth they created.

The consumer price index is based on a bundle of goods and services purchased by consumers in the U.S. and is a measure of the changing cost of such items. http://www.bls.gov/cpi/ Dr. Elizabeth Hoyt was instrumental in the foundational work leading to the creation of this index and I had the pleasure of being officed near her at Iowa State University during the final year of so of her life and career when I arrived there in the late 1970's. She was in her upper 80's at the time of her death but still came into her office frequently.

According to the most recent release of the index for January 2008, energy costs are on track to rise over 40% (based on an annualized average of the last three months) and food costs are rising at an average rate of about 4.3%. Of course averages betray the distribution beneath.

The rapid acceleration in new ethanol plants over the last couple of years has resulted in current production capability reaching levels approaching the 2012 targets of the government mandates. Those mandates were for 7.5 billion gallons. Current production is estimated well over 5 billion gallons. Refineries currently under construction and/or expansion will add another 6 billion gallons of capacity if they are completed and come on line as planned.

By the end of 2006 we had achieved about 1.5% oil energy independence because of ethanol substitution according to the USDA. By 2017, if the massive growth they have forecasted actually arrives, we will be up to 3.7% oil energy independent compared to current purchases. This doesn't take into account the foreign oil used to produce ethanol in all of the various ways it works into the production process for corn etc. but if accounted, it would reduce these percentages by about one third.

Sometimes a picture is worth a thousand words. It is instructive to look up a chart of the prices for ethanol, oil and wholesale gasoline. If you go to one of a dozen easily navigated financial sites, you can take a look at price relationships between these three commodities by charting the December contracts in each.

If you examine the December 2007 futures contract for oil, wholesale unleaded gas and ethanol you will see that gasoline and oil have a very similar pattern, namely, rising throughout the summer months, peaking in July and falling through about August 20th. From that time until now, there has been a steady climb in both oil and unleaded gasoline for the December months.