Oil Prices: What to Do?

In the past several posts on the recent run in oil (and gasoline) prices several commenters have basically laid almost all of the blame at the feet of the oil industry. They ignore data indicating that world supply is low relative to pruduction last year. They ignore the increased demand in places like China. They brush off things like it is the start of spring and the driving season. Instead the problem is all due to big bad evil oil companies.

So, to all those who think this way here is the question: What should be done about it?

Leave your suggestion in the comments.

Moved from 15:53 April 27, 2006 to get more discussion.

FILED UNDER: Economics and Business, , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. DC Loser says:

    Steve, I buy all the arguments you make about the tightening supplies. But what about the oil company profits? Do they or do they not indicate an increased level of profits due to the higher prices? I think this wouldn’t be an issue of the profits didn’t rise so much along with the price of gasoline. I just follow the money.

  2. Steve Verdon says:

    DC Loser,

    The oil industry’s profit margin in about 8%. Pharma compnanies are around 18%. So what should we do to the Pharma companies while were at it?

    Oh, and was is a good profit rate? 5%? 2% 0%? Negative?

  3. hugh says:
  4. legion says:

    The $100 rebate thing is absolute crap. It does nothing to address gas prices, it does nothing to address the possibility of collusion or price fixing in the oil industry, it does nothing to encourage using less gas – it is pure bread-and-circus. Worse yet, if people acutally spend it on gasoline, it becomes, in effect, a transfer from gov’t revenues directly to oil company profits, actively making the situation we’re in now worse.

  5. Dave Schuler says:

    I’m afraid my objectives are different than most people’s. First and foremost we should stop subsidizing consumption. And we should eliminate the direct subsidies that the oil companies receive (there are lots of them).

    After that we need to engage in a serious discussion of the degree to which oil companies are externalizing their costs and how much we want to allow that to continue. That’s different than the “excess profits” discussion which I think is useless.

    I have no problem with executive compensation although I think it’s legitimate to debate how much of that is the legitimate cost of running a business and how much isn’t.

    legion, I think you ought to reconsider the rebate issue. To the degree that the concern about rising oil prices is concern about the pain falling disproportionately on those in lower income quintiles it’s not a crazy idea.

  6. Steven Plunk says:

    So far I hear no blame being placed upon the world’s dominate oil cartel, OPEC. Most of these countries dislike the west and benefit from high crude prices. It’s a two-for, hurt us and collect more money. What better way to fund the jihadists.

    OPEC countries also limit further development of production facilities in order to keep control away from the private sector and therefore the free market.

    Energy is far from a free market commodity. Between OPEC and environmental regulations oil is in reality a heavily regulated good controlled by governments. We know how that turns out.

    Since it is not a true free market we should not apply simple free market formulas and ideas in our analysis. It has become a weapon for foreign policy to many in the world (Iran, Venezuela, etc.). As such rational market forces may and have collapsed to some degree.

    These failures have been amplified by the new speculators in oil futures markets. For example, someone explain why crude prices would go up when refineries go off line? With less refinery demand crude supplies should increase and prices fall. Gas should go up but not crude. Yet when Katrina hit the refineries crude went up in price.

    What should be done? A full scale attempt to break the cartel and a reduction in environmental regulations that hamstring the industry. Rapid increases in all exploration and development could help break the cartel. What’s interesting about the cartel is that it is less an economic cartel than it is a cultural and religious cartel formed to consolidate power in the middle east. The strategic plan of Bush to promote democracy in the region would help put economics back into the equation and break or lessen the power of OPEC.

    Strong leadership in other areas such as Nigeria would help stabilize the world’s production and calm markets. Long term cooperation with Russia would cement ties and push large volumes of oil into the world market.

    The answer is complicated but the first step should be our leaders explaining how complicated it is and all the different steps we can take to solve the problem. It will take years and everyone wants an answer now.

  7. John Burgess says:

    As a first step, I suggest strangling all economic idiots in Congress or on TV and radio when they start mouthing off with the populist pap.

    Since that’s likely illegal, then I’ll suggest voting against them come Election Day and not listening to them while they broadcast.

  8. Get less dependent on oil. But for the last thirty years we can’t seem to get past the whining stage and actually do anything about it.

  9. spencer says:

    Over the last quarter century public policy has been essentially to let the market determine supply and demand in the energy market. About the only thing the government has done is on one hand keep us from drilling in ANWAR — the increase in supply from ANWAR would have been about the same as the drop in supply stemming from our invasion of Iraq — and on the other hand increase the subsidies we give energy firms — it is essentially impossibble to calculate oil companies effective tax rates in the US.

    In the late 1970s, early 1980 when the real oil price was high the oil industry undertook a program of massive over investment that generated surplus capacity for some 20 years.
    Now, demand growth has finally eliminate the surplus the market created 20 years ago and we are back to where we were in around 1980. Apparently we have learned nothing from this experience and as Brad DeLong said, Democrats favor high oil prices except when the price of oil is high and Rebublicans favor the free market except when it creates high oil prices.

    Oil prices will continue to rise until a recession kills demand. But the difference between now and the 1970s is that in 1970 the high prices stemmed from a supply shock and this time it is a matter of demand pull.
    That implies we have a long way go and oil prices have yet to peak and nothing washington will do will make any difference.

    So sit back and enjoy the ride that the free market is providing you.

  10. Bhoe says:

    The delusions continue, Steve.

    You hit the nail on the head–it is a problem of increased demand and decreasing supplies.

    There is nothing that Bush and his silly hydrogen cars and corn fuel can do to address this structural problem.

    The other thing that is missing is the growing likelihood that we are reaching peak oil and that supplies of oil and natural gas are in a process of consistent decline.

    Therefore, you should be basking in the glory of $3 per gallon petrol–in a couple of years we will see prices triple.

  11. TJIT says:

    On the gasoline side

    Remove the tariff from imported ethanol, make sure they don’t put a tariff on imported bio diesel.

    Mandate tailpipe emissions not gasoline formulas, and make them more uniform. Relax standards but reduce overall pollution by subsidizing replacement of older more polluting cars with newer, more fuel efficient, less polluting cars. Further reduce pollution by focusing pollution enforcement on older more polluting cars.

    Give tax credits for implementing flex work schedules (4 ten hours days, etc) and telecommuting.

    Build a new refinery somewhere, they have been trying to build a small one in Arizona for 15 years maybe they will get it done. Does not have to be real big just enough to take the edge off if another refinery blows up.

    On the oil production side.

    Stop jawboning the oil companies.

    The oil industry is facing a critical shortage of help and we need more engineers, geologists, and geophysicists. The prudent student looks at the history of low prices and mass layoffs in the oil industry and decides not to work in the business. The jawboning makes that decision even more rational.

    Furthermore lots of countries have petroleum producing basins. Political risk is a fact of life in the oil business and all this talk of investigations, and breaking up the oil companies, and windfall profits taxes make these other areas less risky then the US.

    Take the portion of the roylaties from production on federal lands that is not needed for management of those lands and leases and give it to the people that reside in the states where the oil was produced from.

    Stay out of the way of the ongoing exploration effort. A tremendous amount of money and effort are being spent to find and produce new oil and gas reserves. Spread rate on deepwater rigs is reaching $650,000 per day. Shipyards are working over time to build new rigs of all classes from land rigs to jackups to deepwater floaters. New seismic exploration boats are being built and exploration crews deployed to find and develop new oil and gas reserves.

    The politicians and the populists need to decide whether they want cheap sound bites and punitive policies toward the oil companies or whether they would rather have more oil produced. They can’t have both.

  12. TJIT says:

    DC Loser,

    You have to remember that oil companies produce crude oil as well as refine it. A big chunk of oil company profits are from oil production not refining. You followed part of the money but missed a big chunk of it by ignoring the revenue from oil production.

  13. TJIT says:

    Steven Plunk,

    Oil prices that are too high aren’t helpful to OPEC. High oil prices make OPEC competitors (Canadian oil sands, Gulf of Mexico deepwater wells, etc) profitable and lead to increased production from regions outside of OPECS control.

  14. TJIT says:

    Steve Plunk, you said,

    “For example, someone explain why crude prices would go up when refineries go off line? With less refinery demand crude supplies should increase and prices fall. Gas should go up but not crude. Yet when Katrina hit the refineries crude went up in price.”

    Big, big, big sigh

    A quick google search found this information from an MMS engineer
    —————————————-
    Statistical Highs

    Shut-in 9.418 BCF and 1.557 MMBbls

    Evacuated 660 manned platforms and 89 rigs

    46 platforms destroyed
    20 platforms with extensive damage

    4 jack-up rigs destroyed
    6 semi-subs / jack-ups adrift

    ——————————————-

    So at one point more then 1.5 million barrels per day of oil were off the market because of hurricane Katrina, don’t you think that might account for some of the increase in the price of crude????

  15. TJIT says:

    Steve Plunk,

    Thank you for making this common sense statement in your comment, it is appreciated

    “The answer is complicated but the first step should be our leaders explaining how complicated it is and all the different steps we can take to solve the problem. It will take years and everyone wants an answer now.”

  16. McGehee says:

    The $100 rebate thing is absolute crap.

    My sentiments exactly.

  17. What should be done about it? Nothing.

    Prices go up, people use less thus lowering demand, and new production is initiated thus increasing production. We’re talking third grade economics here (literally, my third grader had a study sheet on it this week). Instead, I expect the cartels, i.e., Republicans and Democrats, to do everything possible to exascerbate the situation for their own benefit.

    But this pesky freedom thing must be done away with, since it causes far too many problems.

  18. Charles isn’t wrong here.

    As we said in our post over at the Oil Drum on this (that Steve so nicely linked to a couple of posts down), there’s a list of things that can be done from both the supply side and the demand side…but the whole issue is being approached in such a partisan manner that nothing productive is getting done and the rhetoric is nothing but inflammatory.

    If there’s one issue that could unite the country right now, it’s energy. We need leadership beyond partisanship, simply put.

  19. Barry says:

    One thing we could do is for the state and federal gov’ts to quit mandating all these different blends of gasoline. We need a handful at best: deisel, jet fuel, and a few grades of unleaded.

    Make building new refineries a matter of national security.

    Let’s produce more crude oil right here in the US.

    Make a V8 engine that’ll run on natural gas, ethanol, or 85 octane, whichever is available.

    This is America. We invented the computer chip and the moon rocket. We can solve this energy problem.

  20. Bithead says:

    most of obtaining a solution to a problem, is correct identification of the problem. In this case there are several;

    1: ‘Seasonal Blends’ It’s ‘Enviro friendly’ to create gasoline that burns at it’s best under certain driving conditions. Supposedly. Yet, it does cause supply restrictions, given point 2, which is a limited refining capacity. Re-tooling this limited capacity to create these blends every few months, costs the refineries millions every year. And they actually have to stop making gas while the production line is shifted to the new blending, thus making supply/demand even worse. Where do you think that cost difference goes? Thank you, un-American left for forcing this enviro-wacko nonsense on us. If the Democrats were really serious about lowering the costs of fuel, don’t you think we’d see them eliminate this enviro-wacko madness?

    2: Limited refining capacity: We have not built one new refinery since 1976.Our current systems are running at around 95%, despite the gyrations of the different blends we’re forcing though every few months… see point 1. Worse, we’re losing some of the refineries we now have online because they can’t deal with the regulatory load placed on them in the name of the ‘environment’, and the outrageous taxation on the investors in those companies and the companies themselves, al of whom make such systems possible. Thank you, un-American left for forcing this enviro-wacko nonsense on us. If the Democrats were really serious about the cost of gas and heating oil, don’t you think they’d get serious about eliminating the mountain of red tape and impediments we’re up against in the task of increasing our refining capacity?

    3: World demand: The third world, along with places like China, for example, are seeing their energy demands increase. It’s interesting to note that as such they’re not working under the same environmental regulations nightmare we are here in the states and thus their gas prices are far cheaper. Wonder why manufacturing jobs are moving to China, and what is responsible for such shifts? The cost of energy being lower there is a large chunk of the deal. Thank you, un-American left for forcing this enviro-wacko nonsense on us. If the Democrats were serious about the cost of fuel, don’t you think they’d call for our *adding* to the world supply? Which is a nice tie-in to;

    4: Lack of domestic drilling: We have oil here in the US; lots of it, but the usual suspects won’t let us drill for it; ANWR, for example would be turning out about a million barrels a day. Think that’d help? Remember, Bill Clinton vetoed drilling there, and the Democrats in Congress blocked the idea when Mr. Bush re-proposed it more recently as a part of his energy bill. Thank you, un-American left for forcing this enviro-wacko nonsense on us. If the Democrats were serious on this topic, don’t you think they’d be willing to allow us to drill for our own oil?

    5: Taxes: Not only are we dealing with tax levels amounting to as much as 70 cents per gallon in many states, particularly in the left-leaning north eastern states, but we’re also paying a very heavy tax burden when is placed on the oil companies, and everyone in the delivery process… all of which adds to the cost you and I pay at the pump…. Because they pass it along as a cost of doing business. If the Democrats were really serious about lowering the costs, don’t you think they’d lower the taxes both on the oil companies and direct taxation on the buyers at the pump.. Both of which come out of your wallet?

    6: The growing world economy; More or less a good tie-in to point 3… As the World economy recovers from Clinton, we’re seeing increasing demands and somewhat shorter supply. This is normal in an economic growth pattern. But this wouldn’t be a problem, but rather a blessing, had the rest of the factors not been in place. And all the rest of the factors are directly attributable to the left.

    Remember that when you go to the pump, gang. You’re paying for the snail darter. Doesn’t it feel good?

  21. Christopher says:

    It’s all liberals fault! LOL!

    (I’m not kidding, it really is!)

  22. LJD says:

    iF WE WENT TO WAR FOR OIL, THEN ITS TIME TO TAKE IT!

  23. Wayne says:

    It is nice to see from most of the post that there are people out there who are more inform than the politicians. One word on the subsidies to the oil companies, most of the subsidies are design to get the oil companies to do something they would not do otherwise. For example researching alternative fuels. Do I agree on all the subsidies? No. People should keep in mind why they get it and be willing to take the result if they are taken away.

  24. Dave Schuler says:

    One word on the subsidies to the oil companies, most of the subsidies are design to get the oil companies to do something they would not do otherwise

    Unfortunately, that’s simply untrue. Lots of the subsidies that the oil industry gets defrays the expenses of doing things they’d do anyway. It just makes it more profitable to do it.

    And, Steve, about the 8% chart that you and others have been showing. Sure, there are industries that have a higher ROI than the oil industry does. But there are also lots of industries that would kill for the 8%. Perhaps a chart that relates profitability by sector to GDP would be appropriate at this point.

  25. McGehee says:

    …most of the subsidies are design to get the oil companies to do something they would not do otherwise. For example researching alternative fuels.

    I won’t address the first clause, I’m merely including it here for context. What I want to address is the idea of having the oil industry carry the water of researching alternative fuels.

    If I were in the oil business, I would look at alternative fuels in one of two ways:

    1. Potential competition for my main interest and area of expertise, which is oil. It would be at best a distraction and a diversion of resources from what I got into the business to do, and what I know I’m best at. I’d rather not bother with it — which means if oil is one day supplanted by some other energy source, I’m going to go broke faster than you can say “peak oil.”

    2. A way to diversify my business and give it a headstart into the next generation of the energy industry, in the event that oil ceases to be the primary fuel of Western civilization — which means if the assumptions about oil and about alternative energy, on which I’m basing my decision, prove to be unfounded, I’ll find I’ve been pouring money down a rathole.

    Either way, I should have to make a choice and risk the consequences.

  26. Dave Schuler says:

    In complete support of McGehee’s line of reasoning above, I’m really baffled by the idea that the taxpayer should subsidize the oil company’s R&D (or, honestly, anyone else’s). In fact I believe that the assumption by the oil companies that’s what we’re going to do deters them from making investments they’d otherwise make.

    I think that the entire idea stems from a Fordist idea of federal government technocrats allocating funds for “private” companies to perform research, directing what kind of research will be done and who will be doing it. Five year plans.

    That’s poppycock. Technology is just progressing too quickly for any government bureaucrat however wise and all-knowing to make that sort of decision.

  27. Wayne says:

    Here is a link to one of those tax watchers site that donâ??t like subsidies.
    http://www.taxpayer.net/TCS/fuelsubfact.htm

    I hate arguing for subsidies since Iâ??m not a big fan of them. However if you look at the breakdown from this hostile site you will see that $3.85 B of the $5 B of the subsidies goes to public related utilities, research, health benefits, and recovering of remnant resources that otherwise wouldnâ??t be used. Which ones should we do away with?
    I wouldnâ??t mind doing away with all even with the understanding that it would probably hurt those programs.