Photo courtesy of futureatlas.com

Until the credit crunch crisis and recession-speak took over the national and international debates, it was bad Big Oil that was hurting America and its citizens’ inalienable right to drive.

Four-dollar gasoline was all Big Oil’s doing and Congressional investigations were well on their way to uncover all sorts of evil from anti-trust to outright conspiracies, or worse. The election was at stake and while political posturing by some used Big Oil as the regular whipping boy, the economy tanked and oil and gasoline prices followed suit in a decline whose speed was unprecedented in history.

Oil prices peaked in July 2008 at almost $150 per barrel. But proving once again that this is a margin business where small percentages of over- or under-supply can cause wild fluctuations in the price of both oil and refined products such as gasoline and diesel, starting around March and April 2008 there was some barely then noticeable movement. Gasoline demand dropped by a mere 1 percent from a level of about 280 million barrels per month, compared to 2007, this after a 10 percent growth since 2000.

But by last May, the monthly decline from the previous year became 4 percent, then grew to about 6 percent in August and September, the peak of the driving season. By December, after the election, the shortfall was less than 3 percent and by January 2009 it was back to an imperceptible 1 percent. But what happened during those critical months was the huge decline in gasoline prices and in some parts of the country, regular gasoline was selling for $1.50 a gallon, eventually settling around $2. By then the price of oil dropped to $40 per barrel, steadying around $50.

Of course what all these events showed was that oil companies, many of which are anything but big, helplessly watched along with the other sectors of the economy as its fortunes decline, only in an even more precipitous way.

The politicians who were grandstanding when gasoline prices were over $4 are now nowhere to be found to point out the beneficial effects of lower oil prices to the American consumer and the economy. Many of them may lament at least quietly the price decline because they can no longer justify some radical social engineering, motivated by ideological gobbledygook. The notable exception is the Secretary of Energy, Steven Chu, who is quoted as saying “Somehow we have to figure out how to boost the price of gasoline to the levels in Europe.”

A bit of calculation is in order. The US uses a little less than 15 million barrels (about 600 million gallons) of gasoline, diesel and jet fuel per day. At about $2 per gallon, that the American consumer does not pay from the $4 dollar highs, this translates to $1.2 billion per day or about $440 billion per year.

Used for transportation, arguably one of the most potent segments of the economy and by applying a modest multiplier equal to five, the reduced gasoline, jet fuel and diesel prices translate to more than $2 trillion, at least twice as big as the deficit-generating government stimulus package.

It is a foregone conclusion that oil prices and gasoline prices will bounce back and the cries against Big Oil will resurface.

I have calculated the break-even price for many petroleum producing areas of the world and by weighing their contribution to the total world production, we can calculate the world equilibrium price. A critical variable is the discount rate or the time value of money. This ranges from about 10 percent in stabilized parts of the world such as West Texas to, perhaps 50 percent in Nigeria. For places like Russia and Venezuela, the risk is such that discount rates for most serious oil companies would be 100 percent or more. For Iraq it is still in the stratosphere. With all of the above the world break-even price is about $70. This is, of course, the average, meaning that in some places it is $30 and somewhere else may be over $90. The bottom line is this: Oil below $70 simply cannot generate new production in great swaths of oil places and some of them are huge, like Russia and Venezuela. By next September or so, the demand destruction experienced a year earlier will evaporate because of the reduction in drilling activity. Then the price of oil will take off in its upward trend again.

But in the meantime, the economic stimulus because of reduced prices is second to none.