Price Gouging and Posturing Politicians

Ronald Bailey has a good article over at Reason that looks at the recent posturing by politicians to try and benefit from the dissatisfaction over the increase in gasoline prices.

Gasoline prices rose to historic highs this week and Americans are feeling all of that pain at the pump. Trilby Lundberg, the head of the California-based fuel market research firm, the Lundberg Survey, calculates that the national average price per gallon of regular gasoline is now $3.18. In inflation adjusted dollars this price breaks the all-time high record price of March 1981 by three cents. In 1981, regular gasoline sold for $1.35 per gallon which would be $3.15 in today’s dollars. So what’s going on?

The natural villain for high prices is, of course, Big Oil. And Congress is rushing yank the industry’s greasy hands from our pockets. Chairman of Congress’ Joint Economic Committee, Sen. Charles Schumer (D-N.Y.) held a hearing this week on whether or not the Big Oil companies should be broken up. Also on Wednesday, the House of Representatives passed the Federal Price Gouging Prevention Act which makes it “unlawful for any person to sell, at wholesale or at retail in an area and during a period of an energy emergency, gasoline or any other petroleum distillate … at a price that is unconscionably excessive; and indicates the seller is taking unfair advantage of the circumstances related to an energy emergency to increase prices unreasonably.” The act does allow that it would not be gouging if the price “was substantially attributable to local, regional, national, or international market conditions.” And according to Lundberg that’s exactly what has been happening in the past two months.

[…]

Earlier this week, Democratic presidential hopeful Sen. Hillary Clinton (D-N.Y.) called for a two-year tax on oil company profits. “What do you think oil companies are doing with their profits?,” asks Routt. “They’re doing what they should be doing—they’re investing it to produce more fuel.” Recent high gasoline prices may be finally persuading oil companies and other refiners to invest in and build the first new refineries in the U.S. since the 1970s. For example, Shell Oil will be spending $3 billion to double the capacity of its refinery in Port Arthur, Tex.

This is all quite accurate. Much of our problem when it comes to gasoline, are self-inflicted. The boutique/regional blends, the ethanol requirement, and the hostility to building new refineries have all contributed to higher gasoline prices. Changing the laws so that there is a single nationwide requirement for gasoline blends would certainly help. When there is a refinery breakdown that affects one part of the country, then gasoline supplies from other parts of the country could help soften the impact. This would be a sensible starting point in addressing gasoline prices, but it is also boring and rather wonky so most politicians will avoid it in favor of the outraged posturing.

Also factor in that demand has been growing world wide, and in the U.S. as well. With increasing demand, a small number of producers, and periodic shutdowns and you have a recipe for higher prices. Does this translate into higher profits for oil companies? Absolutely. However, one has to keep the refinery running, and with all this money hopefully there will at least be an expansion of capacity at existing refineries.

And there isn’t much that can be done to “fix” this problem. Demand for oil is a global phenomenon. Opening up drilling in ANWR or other locations will likely have little effect on the price of gasoline. Switching over to alternatives is just as costly as using oil, if not costly. And capping the price…well ask anybody who was around when Nixon was President (or even Carter, as many of the price controls from the Nixon era were still, largely, in place). Changes in prices signal changes in scarcity. When something becomes more expensive that means, there is, in relative terms, less of it than there was before. If you try to “fix” the problem with some sort of control on prices then you’ll usually end up producing shortages. Don’t believe me, look at what is happening in Venezuala.

FILED UNDER: Economics and Business, Politicians, US Politics, , , , , , , ,
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. legion says:

    “What do you think oil companies are doing with their profits?,” asks Routt. “They’re doing what they should be doing—they’re investing it to produce more fuel.”

    Excuse me, but how does Routt (or anyone, for that matter) actually know this? For a simple corporation, I assume it could be tracked by someone insomniac enough to cross-reference a buttload of annual filings, but for something as large as a multinational oil conglomerate, can the truth of such statement really be determined? Or is all this profit going into executive pay, slush funds, overseas tax hideaways, crooked politicians’ pockets, etc., etc.; with no actual benefit to consumers, shareholders, whoever?

  2. Anjin-San says:

    So when the CEO of Exxon was making over 100k a day in salary, he was investing it all in oil drilling? To think all the profits are being spent in the search for new energy is not very realistic…

  3. cirby says:

    A hundred thousand a day?

    Not just peanuts for Exxon, but peanut shells.

    The market cap (the actual value of the whole company, in stock), is $460 BILLION dollars. They have 106,000 employees. They made $40 billion profit off of $360 billion in sales – a profit margin about “normal” for a good company with their market cap.

    So, among other things, we find that Exxon, like most oil companies is not “gouging,” by any stretch. Sure, the company is making large amounts of money, but they’re the LARGEST COMPANY IN THE WORLD, and are making fairly proportionate income for their size.

  4. Steve Verdon says:

    Legion,

    Well, Bloomberg, is saying that Royal Dutch Shell is going to double the capacity of its Port Arthur refining facility.

    Refining capacity has increased, what has been a problem is that the amount of competition. Firms tend to leave the refining industry, not enter it. Less competition means higher market power for the remaining firms, which then translates into higher prices.

  5. Dave Schuler says:

    Steve, there is something we could do and, given the will, we could do it tomorrow: stop subsidizing gasoline consumption.

  6. Steve Verdon says:

    Dave,

    Yes, and how about we stop taxing it too then?

  7. legion says:

    OK, so Exxon, for example, is making $40 billion in pure profits per year, which economists seem to agree is “acceptable” for a company that size. And Shell is going to increase the size of a refinery in Texas, costing $3 billion (tho Bloomberg doesn’t say how many years that money will be spent over). That still leaves a pretty huge chunk of change unaccounted for (assuming Exxon & Shell’s profits are similar). And it still doesn’t address my questioning of Routt’s assertion.

    I doubt Shell is spending $3b of their own cash to do that – they’re getting subsidized out the arse, I’m sure. I mean, I’m no communist – I like capitalism as much as the next American – but it’s one thing to charge whatever the market will bear when you have something productive to do with the cash. If not, if you’re just jacking prices because the consumer has no viable alternative, then isn’t that the definition of price gouging? The reason cartels & monopolies & price-gouging are bad isn’t because making money is bad; it’s because the purpose of making money is to re-invest it into things & improve society. But if those profits are hoarded & not returned to the economy in a reasonable manner, then what you’ve got is not, as I understand it, capitalism – it’s parasitism.

  8. davod says:

    The size of the operation is what brings out the large numbers. I recall reading that the return on investment for oil companies is about eight percent which is far less than most markets.

  9. cirby says:

    That still leaves a pretty huge chunk of change unaccounted for (assuming Exxon & Shell’s profits are similar).

    Actually,no, it’s accounted for. It went into the pockets of the people who own the stock. You see, it’s called “investing,” and without that promise of what we call “profits,” people won’t invest in large corporations.

    I doubt Shell is spending $3b of their own cash to do that – they’re getting subsidized out the arse, I’m sure.

    Really? Why? All of the real references I can find show Shell and Motiva co-financing the venture, with no money from the US Government. If they were getting any substantial sort of money from the Feds, the various Greenpeace-type watchdogs groups would be screaming it to the heavens. Unless you have some very specific proof that they’re taking government money for that expansion, you’re assuming something not in evidence (or making things up as you go along).

    Now, I did find some evidence that Shell paid at least $2 million to convince community groups (like CIDA) to stop their opposition to the expansion. But let’s not call that “bribes.” Just “incentives.”

  10. Steve Verdon says:

    Legion,

    Where exactly is this money being hoarded?

  11. William d'Inger says:

    But if those profits are hoarded & not returned to the economy …

    What do you presume they are doing with the money? I doubt they are burying it in the back yard. My guess is they are spending it, which by definition, is returning it to the economy. If they are spending it on things of which you don’t approve, that’s life. The Democrats spend oceans of money on things I don’t like.

  12. William d'Inger says:

    There are two issues here — price gouging and political posturing. The evidence for price gouging is ambiguous. The evidence for political posturing is overwhelming. It all hinges on the definition of price gouging. There isn’t one, so politicians are free to posture all they want.

    I propose the following definition: if the five year running average, measured quarterly, of a company’s profits is more than twice the five year running average, measured quarterly, of the prime interest rate banks charge their best customers, then it’s price gouging.

    The last report I read about the price of gasoline in my area of the country said ExxonMobil made a profit of eight cents per gallon and the tax was 39 cents a gallon. In my opinion, that is neither price gouging nor tax gouging.

  13. cirby says:

    I propose the following definition: if the five year running average, measured quarterly, of a company’s profits is more than twice the five year running average, measured quarterly, of the prime interest rate banks charge their best customers, then it’s price gouging.

    Far too low.

    Unless you want to (for example) put people like the founders of Ben & Jerry’s in prison, that is (they managed a lot higher profits than that for quite a while before selling out the company).

    …and how do you plan on compensating a company if they fall below your numbers? If HugeMegaCorp, Inc makes a 1% profit for your five year run, do they get a refund? Meanwhile, AlmostAsHuge Corp, Inc makes a lot more profit, selling gas for less money (they’re more productive), yet you’re going to call them “gougers.”

    Here’s a trick: if a company really “price gouges,” PEOPLE WILL BUY LESS GASOLINE FROM THEM! This way, they make less profit than their competitors, and investors will abandon them (or fire the board of directors).

    If a bunch of companies get together and agree to high prices, that’s “collusion,” and is already illegal.

  14. Fred Harrington says:

    “and with all this money hopefully there will at least be an expansion of capacity at existing refineries.”

    Nonsense. Ronald Reagan found out they did not invest in the economy. They put it in real estate. Today they will put the money in yachts and build standing armies.

  15. Kent says:

    Today they will put the money in yachts and build standing armies.

    The oil companies are building standing armies? Are they also ordering black helicopters?

  16. Bithead says:

    I live in New York. I will not hide my contempt for Charles Schumer.

    Schumer is pandering. It’s that simple. There have been investigation after investigation on the matter of price gouging, and nothing has ever been found, regardless who was conducting said investigation. Thereby a law regarding the prosecution of something that doesn’t exist, clearly is to no effect. Other, of course, been saying “I did something of a price gouging”. Yes, very productive indeed. Or is it? Can his claim on that score really stand up to any scrutiny?

    The reality of the situation is that there is only two ways to decrease the price of gasoline at the pump.

    The first is to lower the amount of taxes being imposed. Schumer as a democrat, so I don’t suppose were ever going to see a tax reduction policy proposed by such an animal.

    The second is to increase supply, by actually allowing the oil companies to establish a new refinery. So, at what point are we going to see a proposal from Charles Schumer to allow a refinery to be built in his fiefdom ?

    Until such time as he does one of the other, (Fat chance) it cannot be said that Schumer has done anything about lowering the price of fuel.

  17. LaurenceB says:

    On this, I tend to agree with Steve. “Gouging” is just another name for “Good Business” as far as I can tell. And frankly, I think it would be good for the country to see the price of gas go sky-high.

    On the subject of profits, it doesn’t bother me at all to see Exxon make obscene profits. But it does bother me to see Exxon make obscene profits while getting huge government subsidies and tax breaks.

  18. Rick DeMent says:

    mark me down for supporting gouging.

    Dave Said:
    there is something we could do and, given the will, we could do it tomorrow: stop subsidizing gasoline consumption.

    Steve said:
    Yes, and how about we stop taxing it too then?

    Ah Steve, fist of all if we stopped the subsidies then I might be open to talk about the taxes, but frankly gas taxes support the maintenance of highways, so unless you want that to be funded some other way … and if you want to talk about keeping oil and gas tax out of the general fund so it goes exclusively for the roads I for that as well. Second of all the States tax oil and gas which is why a state like Texas can afford to have no income taxes to support state functions, now I don’t live in Texas so I’m all for getting rid of that, but I’ll bet the residents of oil and gas states won’t like having to fund their own government like the rest of us do, but I don’t know, ask them.

    But frankly this stuff about refinery capacity is frankly crap. About the only thing oil companies spend there money on these days are securing inventories of future production. Exploration has been in decline for almost 50 years now.

    The refining capacity argument is stupid since the there is no reason to increase capacity if all it’s going to do is reduce prices, on what planet does that make sense? I mean I know the NIMBY argument makes for good copy, and it’s true in a small way, but come on, what kind of fool do you take us all for? If they wanted to build a new refinery the oil companies have the muscle to make it happen. But they know that the writing is on the wall, once we are over the peak there will be less and less oil to feed into the refining process. This crap about NIMBY, environmentalism and boutique/regional blends is just so much kabuki so that don’t have to state the obvious.

    The issue with refining capacity has much more to do with the grade of crude you can refine rather then the capacity and the boutique/regional blends non sense is because the federal government won’t regulate the oil industry on a national basis so the states have to step in and create a patchwork.

    Steve you are truly a friend to big oil, a “useful economist” if you will. It is true that all of the crap about gas prices is stupid, but that simply goes to make the the larger point that oil demand is not as elastic as the flat earth economists would have us all believe. Our economy is built on cheap oil and gas and what that goes away so does the economy built on top of it.

  19. legion says:

    Well, everyone talks about how increased travel during the recent holiday weekend was going to jack up prices. In my area, gas went up at _every station in town_ an average of .15 per gallon a full _week_ before the holiday. That’s _before_ the actual demand could possibly have hit. And now that the travel surge is over, guess what? The prices haven’t come back down, and nobody expects them to. Despite the fact that crude oil prices have remained stable or even dropped lately. That’s not economics, that’s rape.

  20. legion says:

    And as for the meta discussion of supply-side economics that’s evolved here, as other commenters have noted above, Reagan found out the hard way that pouring more money into the ‘top’ doesn’t necessarily force growth out of the ‘bottom’. Rich people given more money don’t magically do things that are primarily beneficial to society, liky building more factories & shopping centers, etc. And they don’t invest it in operations that do anymore – there’s a lot of big money in industries that specifically _don’t_ have a large capital footprint. Any benefits to society are purely secondary, and if a new thing pops up that employs even fewer people & requires less physical inventory (intellectual property, anyone?), investment $$ will shoot straight there, leaving the middle class to dangle yet again. So supply-siders lowered the bar, saying “Well, rich people with more money will buy more luxury items, like yachts and mansions, and_that_ will trickle down and help the poor more efficiently that just helping the poor directly.” Bull. How does a small fraction of the population buying new $100k Beemers and Lexuses (Lexi?) help the economy more than a vastly bigger percentage buying new (or even used) Chevys?

  21. G.A. Phillips says:

    It bothers me to see the federal and state governments make obscene profits on gas for doing nothing more the passing a law, at lest the the people who run big oil bring us gas and other products. As for the federal and state governments who make 2 to 3 times more profit then all the oil companies put together, what do they bring us, and what do you call this kind of gouging? Oh and what in the great blue hell is a capital footprint.

  22. legion says:

    WTF? Equating tax revenues & corporate profits is an interesting tack. As for “what they bring us”, well, I’ll let someone else catalog what fed & state gov’ts do with tax $$.

    But by ‘capital footprint’, I mean the amount of physical ‘stuff’ – land, bldgs, equipment, materials, etc – needed to start & run a business. Fr’instance, starting a new auto plant requires a huge footprint, while a new venture capital of intellectual property joint requires little more than office space. A large-footprint industry has a big (generally, but not always) positive impact on local growth; a small-footprint industry doesn’t.

  23. Steve Verdon says:

    Rick,

    Both are distortionary and if you are going to stop one then stop the other and possibly start over.

    And if it is meant for road maintenance, how come there are still pot holes in the roads?

    Well, everyone talks about how increased travel during the recent holiday weekend was going to jack up prices. In my area, gas went up at _every station in town_ an average of .15 per gallon a full _week_ before the holiday. That’s _before_ the actual demand could possibly have hit.

    Not neccessarily. If people were filling up their “vacation vehicle” ahead of time to beat the price increase, then you could see such an increase. Markets are dynamic, not static and hence your logic, which implicitly rests on a static view, isn’t neccessarily correct.

    And now that the travel surge is over, guess what? The prices haven’t come back down, and nobody expects them to.

    I just passed a gas station on my way to dropping my son at school and they were lowering their prices. And gasoline prices, while seasonal, there are also other factors that play a role in pricing as well.

  24. Mark says:

    And if it is meant for road maintenance, how come there are still pot holes in the roads?

    You say this, then your next sentence criticizes legion’s logic. Funny!

  25. Steve Verdon says:

    Mark,

    I don’t see the problem. The money is to be used to maintain the roads, but they don’t seem all that well maintained. Where is the money really going?

  26. legion says:

    Where is the money really going?

    Oh, it’s going to maintain the roads, just very, very poorly 🙂

    If people were filling up their “vacation vehicle” ahead of time to beat the price increase, then you could see such an increase.

    A few days before the weekend, I could see. But a full week? I don’t buy it – Americans don’t plan that far ahead…

  27. TJIT says:

    Petroleum is just another commodity product. The price cratered in 1986 and the world economy enjoyed years of cheap petroleum and the economic expansion it provided. The price crashed before and it could crash again. The one thing that is most likely to maintain hihg oil prices is ill considered laws driven by political posturing.


    Crash of ‘86 Left Permanent Scars

    in less than 12 months, world crude oil prices fell by more than 60 percent. Hundreds of thousands of oil workers were laid off.

    Texas reported 366,200 jobs related to oil and gas extraction and oilfield equipment in the early 1980s, according to the Federal Reserve Bank of Dallas.

    By 1987, only a year after the price collapse, 175,000 of those jobs had vanished.

  28. TJIT says:

    The US government can’t find oil, it can’t build refineries, or reduce gas prices below the world rate. Most government policy (cough, ethanol, cough) increase gas prices to the consumer it would be helpful if more people were aware of that. Reading the link below will give you a good introduction to just how badly the government can screw things up.

    Economic Amnesia: The Case against Oil Price Controls and Windfall Profit Taxes

    First these policies tend to drive companies out of the US. Given the US demand for natural gas this is a big problem because natural gas can’t be shipped the same way crude oil is.

    Because price controls and profit taxes can be levied only by the U.S. government on U.S.-based companies, such policies also increase the economic attractiveness of foreign relative to domestic oil. The U.S. experience with price controls from 1971 to 1980 and the Crude Oil Windfall Profit Tax from 1980 to 1988 amply demonstrates the problems.

    There is no evidence to suggest that recently reported oil company profits are particularly large when contrasted with the profit margins of all public companies. Profits in the oil sector have historically been lower than profits in the rest of the U.S. economy, so profits would have to be quite large for some time before they equaled returns in other sectors of the economy. Restricting profit opportunities now would amount to a form of one-way capitalism in which meager profits are allowed but more robust profits are punished. Intervention under those conditions would certainly reduce the incentive to invest in the oil business.

  29. TJIT says:

    A couple of other links about refining.

    The question about refining

    apart from a brief decline in the early 1980’s associated with the drop in energy demand at that time, the total quantity of crude processed by the nation’s refineries (known as “throughput”) has been steadily rising, despite the loss of half the facilities. Increased scale of operations at the remaining refineries has more than made up for the drop in the total number.

    And

    $2-Billion Petroleum Refinery in Arizona Would Be First in 28 Years

    Permitting delays, environmental restrictions and high startup costs have prompted owners of U.S. refineries to upgrade or expand rather than build new plants, says Bob Slaughter, president of the National Petrochemical & Refiners Association, Washington, D.C. “There’s definitely a risk in building a brand-new refinery,” says John Paisie, senior director of PFC Energy, a Washington-based energy industry consulting firm. “Refinery margins have not justified that kind of investment.”

  30. Steve Verdon says:

    Legion

    A few days before the weekend, I could see. But a full week? I don’t buy it – Americans don’t plan that far ahead…

    Sure. Think of it as a process and not something that is static. First people start filling up a few days beforehand. The gas stock drop off as a result. So, they have to order more case, and gas becomes scarcer sooner rather than later so prices also go up. Then people move it back a few more days for filling up. Get far enough away from the weekend causing this and the price might drop in between inducing people to start filling up closer to the weekend. Putting it in game theory terms I’d think of it sort of like a mixed-strategy equilibrium.

    By the way, your might very well be right about the road repair/taxes thing.

    Rick,

    You also seem to be confusing refining capacity with the number of firms that are doing the refining. Also, sure the existing firms aren’t going to want new entrants. And we can even look at the expansion of the Royal Dutch Shell facility as a possible way of discouraging entry into the market. It sends a signal, “Enter and we’ll under cut you and drive you out.” Predatory pricing can indeed happen in certain cases, especially when there is a dynamic issue of entry into the market by new firms.

  31. Mark says:

    I don’t see the problem. The money is to be used to maintain the roads, but they don’t seem all that well maintained. Where is the money really going?

    It feels like you are arguing by anecdote.

    How much money does the highway department take in? How much would it cost to maintain the roads to your satisfaction (assuming no corruption or gross inefficiencies).

    If we had difficult-to-obtain data like that, then we could really draw some conclusions. Otherwise we are just making stuff up.

  32. Steve Verdon says:

    Mark,

    Well it is anecdotal, but at the same time, traffic in my part of the country is really, really bad. Seems to me that part of “maintaining the highways” includes doing things to improve the flow of traffic. I see little of that going on. Instead, I see projects of dubious value to improving traffic flow. Again, it is anecdotal, but it is a 5,000 ton anecdote given traffic in the Los Angeles area.

  33. legion says:

    Steve,
    I see what you’re saying, but there’s a problem with your process… unless a significant percentage of Americans own a purely ‘vacation’ vehicle that isn’t used for any other purpose (RV, boat, etc), then there’s a hard limit on how long before a given holiday you can really gas up… I could fill my tank today & say it’s for a trip I’m going to take on the July 4th holiday, but I’ll burn that tank up several times over between now & then just with regular city driving. I don’t think enough people fit into that ‘vacation vehicle’ category to drive the kind of lag we’re talking about here…

  34. Steve Verdon says:

    Legion,

    No, there is no “hard limit” in that some people have one vehicle, and others don’t. That there is a “soft limit” I’d probably agree, but we might see things cycle around inside those limits, so I still don’t see anything malicious here. And the lag you mentioned is one week, not all that long, IMO.

  35. Scott says:

    Congress is considering HR2415 that will encourage $ to go to more and better refineries. It also helps consumers at the pump right away, I think. Worth looking at.