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Pumping Gas Prices

Too expensive? Just wait. Federal and state governments can always find ways to make gasoline even more expensive.

By 10.20.05

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Gasoline costs too much in almost everyone's opinion. President George W. Bush is urging Americans to drive less. Other politicians want government to push prices down.

Sen. Maria Cantwell (D-WA) suggests giving the President the power to set retail gas prices. Sen. Byron Dorgan (D-ND) complains that companies are "profiting in an extraordinary way at the expense of the American consumer" and has proposed a windfall profits tax.

Eight governors have requested a federal probe of gasoline pricing. Illinois Gov. Rod Blagojevich (D) is threatening to prosecute companies over price hikes after the recent hurricanes. So is Republican Kentucky Gov. Ernie Fletcher. Georgia's Gov. Sonny Perdue, another Republican, signed an executive order penalizing gas price hikes. GOP Gov. Matt Blunt of Missouri denounced "price gouging" as "unconscionable and illegal."

They are all moderates compared to some critics. "It's very clear to us that gas prices need to be regulated. We really need to step back and recognize that like electricity, gasoline is too vital to the economy to be left in the hands of these corporations that have been gouging us," argues Doug Heller of the misnamed Foundation for Taxpayer and Consumer Rights in Los Angeles.

Hawaii has imposed controls on wholesale gasoline prices. Several other states may follow suit.

Price controls have been around as long as prices. And price controls have had disastrous effects for just as long. They discourage production and encourage waste, creating shortages. They also penalize emergency preparedness -- stockpiling, for instance. But counterproductive effects have never deterred demagogic politicians seeking votes.

Advocates of price controls apparently believe that the oil companies are artificially jacking up prices. It's a convenient theory, but it makes no sense. After all, if ExxonMobil and Royal Dutch Shell could simply conspire to push up prices, they would have done so last year. And the year before. And the year before that.

In fact, Americans have been spoiled over the last two decades. Adjusted for inflation, gas prices have been historically low. Even today prices remain lower than in Europe.

GASOLINE PRICES HAVE INCREASED for a number of reasons. One is growing demand. The emergence of China and secondarily India as industrial powers is transforming the global market. In particular, the former has turned from net energy producer into a potentially large consumer.

Over the long-term the supply of energy, and maybe even of petroleum, will increase. If nothing else, rising prices increase the incentive for investment and production. The extra 46 cents a gallon now going to crude oil producers is painful for consumers but will encourage additional exploration and production.

Another reason prices are high -- and have spiked in response to the damage inflicted by Hurricanes Katrina and Rita -- is pervasive regulation. Most important, it has become extraordinarily difficult to build oil refineries.

Both the number of refineries and their total capacity is lower today than in 1980. The last refinery opened in 1976, even though gasoline consumption has jumped a quarter since then. Today the U.S. must import ten percent of its gasoline as well as 57 percent of its oil.

Thus, the temporary closure of nine refineries (and reduction in operations at three others) caused by Katrina cut total refining capacity by 12 percent, sharply inflating pump prices. Hurricane Rita had an even bigger impact, shutting 27 percent of America's refining capacity.

Companies are seeking to build more refineries, but environmental regulations, backed by activists who mix demonstrations and lawsuits, create delays and inflate costs. One Arizona project begun a decade ago is still at least five years away from completion.

Over the last ten years the industry has invested $47 billion to comply with new environmental controls rather than construct new capacity, according to the American Petroleum Institute. Compliance with sulfur standards alone cost about $20 billion over four years. Rules involving the additive MTBE, including potential liability for water contamination, raise costs. Although the recent energy bill included provisions intended to spur refinery construction, it added a new ethanol mandate -- a political pay-off to agricultural interests -- which will force expensive technical adaptations at refineries.

Another problem is air pollution rules which mandate use of "cleaner" gasoline in "nonattainment" areas, even though they comply with stringent air quality standards most of the time. The result is more than a dozen gasoline formulations, which reduce economies of scale. Moreover, a disruption at even one refinery can have a disproportionate regional price impact.

Such costs wouldn't matter as much if refining was wildly profitable. But it isn't. Since 1990 refiners have averaged just five cents on the dollar. While consumers target gas stations with their ire, the bulk of recent price hikes have been retained by refiners, which have been collecting three times as much money as only a year ago. In contrast, distributors, marketers, and retailers receive just a penny more than in 2004. And the latter lose part of their small gain in higher credit card fees.

Even today, prices at the pump are constrained by local competition. If gas stations could charge as much as they desired, they would have done so before.

Government also pushes up prices through taxes, which average 42 cents a gallon nationally. In Hawaii, where the state government has imposed price controls, California, and Nevada, the combined state and federal tax is more than 50 cents. This is ten times the average oil company profit per gallon.

Unlike prices, taxes seem to go up and never come down. Since 1980 the federal levy has gone from four to 18.4 cents a gallon, a more than four-fold increase.

HIGH PRICES MAY BE PAINFUL, but they are the most efficient way to distribute goods in high demand. Indeed, the gasoline industry attempts to spread the supply as widely as possible. Wholesalers charge "over-allocation" fees to discourage any distributor from accumulating a disproportionate share of limited resources.

The basic point is simple: prices rise when supplies fall. That signals consumers to use less and sellers to supply more. Price controls short-circuit the adjustment process and intensify shortages. Then the only way to get the item is by queuing.

That was the experience during the mid-1970s gas "crisis." Citizens in the wealthiest country on earth sat in gas lines because the federal government allocated supplies and restricted prices.

Only when newly inaugurated President Ronald Reagan lifted price controls did supplies jump and prices fall. Federal energy regulation was an extraordinary policy disaster that should never be repeated.

The U.S. also imposed a windfall profits tax between 1980 and 1987. Of course, while politicians are ever ready to penalize gains, they won't protect against losses -- as when the average price of a barrel of oil fell below $10 back in 1999.

Alas, the windfall profits tax discouraged companies from making potentially risky investments. In 1990 the Congressional Research Service concluded: "The WPT reduced domestic oil production between 3 and 6 percent, and increased oil imports from between 8 and 16 percent." Replaying the old WPT would replay its effect, cutting production and increasing imports. That would help foreign producers and hurt domestic consumers. But if Sen. Dorgan really believes it to be such a good idea, he should propose imposing one first on farmers, since crop prices also vary greatly over time.

Economics isn't the easiest subject to understand, but politicians should at least try. Sen. Cantwell has charged the oil companies with manipulating the market while allowing that "I just don't have the documents to prove it." As for the right price for gasoline, she admitted: "I don't know what the level should be." No politician or bureaucrat knows the right level.

As Hurricanes Katrina and Rita demonstrated, natural disasters often create economic dislocations and hardship. Adjustments almost always are difficult. But government intervention always exacerbates the pain. If gasoline seems expensive today, just try turning the energy market over to government.

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About the Author
Doug Bandow is a senior fellow at the Cato Institute. A former Special Assistant to President Ronald Reagan, he is the author and editor of several books, including The Politics of Plunder: Misgovernment in Washington (Transaction).