Ethanol Fuels Gas Troubles

[While this story warns of highest-ever gasoline prices by Memorial Day, another story from MarketWatch today is describing the possibility of $7 gasoline this summer. FTW agrees that this summer will be Peak Oil’s “coming-out party” and it will not be pretty. It’s important to note that both stories predict these events without including any projected damage from even one major hurricane. They also don’t admit how seriously Katrina and Rita devastated production facilities last year— a devastation which has not been repaired and, according to admissions from DoE and producers themselves, never will be. Put on your track shoes ladies and gents. Here it comes. – MCR]

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The pain of $4-a-gallon gasoline for your beach trips is already on its way to New York gas pumps - thanks to corn fields in the often-parched Midwest.

Excluding geopolitical troubles, the new culprit being blamed for picking the pockets of motorists this season is a colorless, environmentally friendly liquid called ethanol - distilled from corn or sugar cane into a volatile explosive that soups up gasoline.

Even without threats of hurricanes that typically wreak gas-pump havoc, energy traders are betting - by nearly three to one - they'll see the highest prices ever for gasoline by Memorial Day.

"Leaving out the issue of hurricanes, we're going to see some $4 gasoline appearing in some isolated cases," said Jamal Qureshi, senior gasoline analyst at PFC Energy in Washington, D.C. "If hurricanes really hit the refinery system as in the past - well, we saw what that can do."

Most motorists are unaware of what they're facing this summer driving season when they gas up.

To the anxiety of many energy-watchers, America is switching all its gasoline by May 5 to a new blended gasoline that uses 10 percent ethanol to create its octane rating.

The old octane booster, MTBE (methyl tertiary butyl ether), has been virtually outlawed as a cancer-causing pollutant and won't be used after May 5.

Instead, motorists and gas station operators will have to rely onAmerica having enough corn to keep ethanol flowing in huge quantities to blend their cleaner-burning gas.

New York and Connecticut are already on ethanol, but New Jersey and most of the rest of America haven't yet switched.

"There's some new problems and challenges ahead in the national switch to ethanol," said Qureshi.

"Ethanol doesn't travel well - in pipelines it separates into water and liquids - and has to be trucked wherever it goes."

The blending is also done at the retail level, usually at the wholesale tank farms just before it's trucked locally to service stations.

Once a person assimilates the idea that peak oil and its consequences are imminent, it radically changes one's world outlook. Nearly every issue one confronts will be affected by peak oil. In the last 100 years, oil has become so pervasive in our civilization that few issues or individuals will be immune to the reduced availability and much higher prices that will soon be upon us.

At the top of the list of problems coming with the peaking of world oil production are all manner of economic troubles. Optimistic students of peak oil say, at best, we are going to have a great depression lasting a couple of decades. Pessimists write of much worse. The bottom line is the good times much of the world has enjoyed for the last sixty years will not last long.

Start with the innumerable personal decisions you make every day. Is your job likely to be an early casualty of rising gasoline prices? If you make or sell SUVs, the answer is easy. If your job depends on people's discretionary spending— be wary. The polls tell us people will spend close to their last discretionary dollar on gasoline before giving up driving their beloved and "essential" cars. Thinking of buying or selling a home? The housing situation, particularly in the US, is going to be markedly different in a few years.

If, however, you are a farmer (and not many of us are anymore), you may be on the verge of the golden age. Chances are the world's farmers are going to be mighty busy growing plants that can be converted into liquid fuels as well as food. The golden age for some could start as early as this summer when large quantities of surplus corn are converted into ethanol for use as a pollution reducing gasoline additive. On the other hand, it seems some major droughts are shaping up across the world, possibly even in the US, so the golden age of farming may be delayed for awhile.

If your part of the world suffers from traffic congestion, just wait awhile. We know people will give up a lot of things before they park their cars, but after gasoline gets past $6 or $7 per gallon and a lot of credit cards start maxing out, "non-essential" driving is bound to slow way down. Every car you see on the road will have someplace important to go and I suspect will have more people on board than we see now.

Thinking about a trip? You had better go soon. The International Air Transport Association just reported the collective fuel bill for all the world's airlines topped $92 billion last year, up 50 percent from 2004. It is not hard to imagine that airfares currently measured in the $100s will one day be measured in the $1000s, leading to a marked reduction in air travel.

Currently, one of the top political issues in the US is immigration policy, so it is fair to ask what insights a peak oil perspective might have on this issue. There would seem to be two sides. As people who have been following peak oil are aware, oil production in Mexico has started into decline and just might decline very rapidly. As the Mexican federal budget depends very heavily on oil revenues, Mexico, and indeed all of Central America, may be faced with some very tough times ahead leading to increased pressures to migrate north.

In the US, the role for immigrants will largely be determined by how well the economy fares in the early years of peak oil. As long as the GDP continues to grow and unemployment is low, there will be a demand for immigrant labor. However as the economy weakens from steadily increasing oil prices, laid-off workers will be willing to take less-desirable jobs, thus displacing immigrants. While some types of jobs that have come to be filled largely by immigrants —agricultural and meatpacking— should continue at current levels. After all, we have to eat. Others, such as construction, landscaping, hotel and restaurant work, are likely to see a substantial decline with the advent of a peak oil induced depression.

The last point to ponder a bit would be the role of government, at all levels, in a post peak world. We no longer live in a 19th century world where most of us lived on farms and could more or less provide for ourselves. We have become so dependent on elaborate networks of transportation, energy, and communications to sustain our lives, and there are now so many of us -- 300 million in the US, 6.4 billion in the world --- it is clear governments are the only entities with the authority and the means to get us through to the post peak oil world.

If you are skeptical of this, ponder 1929 to 1945 and the pervasive role that government came to play in the economy and our lives during the depression and the ensuing war. There seems little doubt that the problems coming with peak oil will be comparable to those of the 1930s and '40s.

Major trading companies have launched efforts to secure uranium fuel for nuclear power plants. Itochu Corporation will obtain the rights to a uranium concession in the US, and will begin producing 400 tons annually as soon as 2009. Sumitomo Corporation is participating in the development of a concession in Kazakhstan. In the fierce competition for resources, overseas resource development companies are out in front. Because there are increasing plans for nuclear power plant construction around the world due to concerns about high oil prices and environmental problems, Japanese companies too are hurrying to secure resources.

Itochu will be producing uranium at Church Rock in southern New Mexico (about 6,000 tons confirmed recoverable uranium), the rights to which are 100% owned by the US developer Uranium Resources (Dallas, Texas). Itochu will invest about 4 billion yen to obtain 50% of the rights, and produce uranium under a 10-year plan beginning in 2009. The amount of uranium to be produced represents about 4% of Japan's annual consumption. It will be supplied to electric utilities in Japan, the US, and other countries.

[Three categories make up the Money Supply: M1, M2, and M3. The Money Supply helps economists to understand how policies will affect interest rates and growth. Definitions of M1, M2, and M3 categories within the money supply are as follows:

M1 - includes physical monies such as coins and currency. Also includes demand deposits (checking accounts) and NOW accounts (interest-earning bank accounts within which the client may write drafts against deposited monies). Another synonym for M1 is “narrow money” because the M1 category is considered to be the narrowest idea of money. Economists use the M1 category to quantify the amount of money in circulation.

M2 - includes all M1 categories, time-related deposits (such as CDs), savings deposits, and non-institutional money market funds. Economists use the M2 category to not only quantify the amount of physical money in circulation, but also to try explaining various economic monetary conditions.

M3 – includes all M1 and M2 categories along with large time deposits (such as lengthy CD terms), institutional money market funds, short-term repurchase agreements (short-term borrowing agreement for government securities dealers), and other large liquid assets.

MZM – “Money Zero Maturity” measures the liquid money supply in the economy. It includes all monies in the M2 category except for time deposits, and adds-in all money market funds. It is essentially a mix of all of the liquid monies and zero maturity monies found within the three categories of the money supply. MZM has become a preferred measure of the money supply because it represents monies available for spending and consumption in the economy.

- FTW]

Each week the Federal Reserve reports various measures of the US dollar money supply. One of these, M3, is the total quantity of dollars in circulation. Last week the Fed stopped reporting M3, explaining as follows the reason for their decision:

“M3 does not appear to convey any additional information about economic activity that is not already embodied in M2 and has not played a role in the monetary policy process for many years. Consequently, the Board judged that the costs of collecting the underlying data and publishing M3 outweigh the benefits.”

To the casual observer not familiar with the nuances of central banking, the above stated reason may seem plausible. But those with experience know that central bankers only tell you what they want you to hear. Therefore, what is the real reason the Federal Reserve stopped reporting M3?

The answer is very simple. The Federal Reserve wants to hide the truth. They want to hide the fact that they are inflating the dollar.

The Federal Reserve says that M3 is no longer needed, and that M1 and M2, which only measure part of the total quantity of dollars, are sufficient. But look at the following table which I’ve taken from the Federal Reserve’s last money stock report that included M3.

H.6 (508) Table 2
Money Stock Measures
% change at seasonally adjusted annual rates
	M1	M2	M3
3-mos from Nov 05 to Feb 06	1.4%	6.6%	8.7%
6-mos from Aug 05 TO Feb 06	0.6%	5.8%	8.7%
12-mos from Feb 05 to Feb 06	0.4%	4.7%	8.0%

Inflation arises from creating too many dollars. Therefore, compare the growth rates of M1 and M2 to that for M3.

Regardless whether you use the 3, 6 or 12-month reporting period, by looking at just M1 or M2 growth rates, one would get the impression that the level of current dollar creation was not unusual and that as a consequence, no inflationary pressures were building within the economy. But M3 reveals the truth, and the truth is that the Fed is pumping up the money supply. The total quantity of dollar currency is soaring, which is also apparent from the following chart which shows the annual growth rates of M3 at each month end since January 1975.

This chart provides a useful roadmap that illustrates the inflationary and disinflationary trends in the US dollar. There was double-digit inflation in the 1970s because M3 was growing at double-digit rates. Paul Volcker was appointed Fed chairman in 1979 and given the mandate to bring inflation under control. He achieved that objective by ushering in a period of disinflation by deliberately implementing a monetary policy that resulted in the declining M3 growth rates clearly visible on the above chart.

After his appointment in 1987, Alan Greenspan continued the same disinflationary policy until September 1992 when the quantity of M3 had actually declined from the prior year. This decline in the money supply was deflation according to its classical definition, but this brush with deflation was brief. The Fed began reflating, and continued to do so until Y2K, in the process creating the greatest stock market bubble of all time. Thereafter, M3 growth rates began to decline along with the US stock market, bringing in another period of disinflation. But look at what is happening now.

I have highlighted with the red circle the recent trend in M3 growth. The rate of dollar creation has begun a new upward path, which I call the “Bernanke Inflation”. It is this new upward trend that the Fed does not want anyone to see.

By not reporting M3, the Federal Reserve thinks they can inflate without consequences. As evidence of this conclusion, please read the following quote from a presentation given on March 13th by Janet Yellen, president of the Federal Reserve Bank of San Francisco. To provide some necessary background information, she first explained in effect that expectations by the public for future inflation have consequences because their expectations cause people to take actions to protect the purchasing power of their dollars. She then goes on to state:
http://www.frbsf.org/publications/economics/letter/2006/el2006-05.html

“Over the past two years, wages, core inflation, and long-run inflation expectations have remained well contained despite a dramatic increase in energy prices. With inflation expectations under control, we have avoided a rehash of the 1970s and the need to rein in inflation by engineering a severe recession.”

In other words, if people don’t believe inflation is a problem, the Federal Reserve has more opportunity to intervene, taking actions potentially debasing and inflationary to the dollar and to do this without consequences. Or at least that what’s the Fed thinks. But the Fed is only fooling itself.

First of all, who really believes that inflation is under control? The price of everything is going up, except perhaps computers, but in contrast to food and energy, computers are not an everyday purchase. A poll published by The Wall Street Journal reveals that 75% of those participating believe that the inflation they experience is worse than the inflation rate reported by the federal government’s Consumer Price Index.
http://discussions.wsj.com/n/mb/message.asp?webtag=wsjvoices
&nav=messages&msg=3843&mod=?mod=hps_us_inside_today

So who does the Fed think it is fooling? After the Fed made its initial announcement in November 2005 that it would discontinue M3, I wrote:

“By eliminating its reporting of M3, the Fed is shooting itself in the foot. This misstep will only hasten the rush out of dollars into the safety and security of gold.”

The reason for forecasting as I did a flight from the dollar into gold is that I suspected that the Fed’s decision to discontinue its M3 reporting would be immediately recognized for what it is – something to be expected from a ‘banana-republic’. In other words, if things are that bad that the Fed is no longer going to report the whole story, then, the thinking goes, the sooner one exits the dollar the better. And the best way to hedge oneself against the effects of inflation is to buy gold.

Clearly, the rise in the gold price that has occurred since the Fed announced in November its decision to no longer report M3 must in part be attributable to this gross misstep by the Fed. Given the new upward trend in the M3 growth rate on the above chart, it seems inevitable that the price of gold is going to rise much higher because inflation will continue to worsen, regardless whether the Fed reports it or not.