What To Do About the Oil/Gasoline Prices
Well, this is a follow up to this post on what to do about oil prices. Also, a there are a number of responses in this post on the oil/gasoline situation that are related to the issue of what to do that are worth responding too.
Lets start off with a good suggestion from Dave Schuler and also suggested by commenter Herb,
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).
This is a good idea. For an industry that is earning tens of billions a year in profits the idea that they need subsidies is just galling in the extreme. Every penny they get in federal and state subsidies should be revoked. With oil and gasoline prices high the oil companies have a strong incentive to produce at near maximum capacity. They don’t need anymore incentive from the taxpayer. Further, taxing the consumers and giving the money to the oil companies is inefficient. So eliminate these subsidies, yesterday.
The next comment is from Steve Plunk,
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.
While it is true that OPEC likes higher prices they aren’t going to push the price so high that alternatives start to look attractive. Further, there is another problem with high prices. Higher prices induce production from non-OPEC members as well as creates an increasing incentive for individual members to “chisel” on the cartel agreement–that is produce above their quota. This has happened in the past. Further, oil prices that are too high could trigger a recession and this by itself will curtail consumption.
This last idea is highlighted in the comment by TJIT. Steve Plunk also brings up the idea of “breaking the cartel”. How? The only way that I see this happening is invading the member countries which wouldn’t go over well even if our military could do it. OPEC’s power as waxed and waned in the past, but that is due more to the internal bickering/maneuverings of member countries and also partly in response to consumer conservation. Breaking the cartel is unlikely to happen and even if it could be done I doubt it would have much impact on prices as the current high prices are so much of a supply side issue (at least in terms of oil) but more of demand side issue.
Countries like China and India are consuming more. This increased consumption at all price levels is very much like a rightward shift in the demand curve. Holding the supply curve fixed this translates both into increased production and increased prices.1 Recall this post where I pointed out that in the futures market oil in contango. This is where the futures price for delivery a few months down the road is higher than the spot market price. When this happens refineries tend to opperate at the “top of their tanks”, that is the storage tanks holding oil are full. So there is plenty of oil on hand, the problem is that the price is high right now, and looks the way the market looks will be higher in the future. The implication is to hold oil, and produce oil.
Barry has a good idea,
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.
I doubt this would do much to reduce the price right now, but it certainly could help make the gasoline market less volatile. Whenever there is a shortage in one part of the country production in another part could be shipped to the region with a shortage, thereby mitigating the rise in prices; basically spreading the pain around at a much lower level.
The idea of making building refineries a national security issue is something I’m unsure about. First of all, building a refinery anywhere is going to be a huge and long term process, I’d say at least 5 years. So for prices right now it would do pretty much nothing. Further, I’m not convinced that everything that is deemed “important” should be classified as “national security”. Pretty soon we’d be seeing gay marriage and the opposition to gay marriage couched in terms of national security.
Bithead has touched on many of the topics we’ve already mentioned, but also brings up ANWR and domestic drilling. I doubt that this would do much either. How much could ANWR produce per day? The high estimate is 1.6 million barrels per day, and that would be several years down the road. Perhaps wise from a long term strategy view point, but would do little to affect prices today. Further, another thing to consider is that oil prices are set by a global market and the total global production of oil per day is 85 million barrels. So an additional 1.6 million barrels, while not insignificant, wouldn’t do much to reduce prices.2
Bithead also mentions reducing the taxes on gasoline. While this would have a short term effect of lowering the price of gasoline it would also cost the federal and state governments quite a bit of revenue, and given that these governments are running deficits or would be running deficits without these revenues, that would mean eventually higher taxes. Further, such a reduction in the price would actually encourage more usage of gasoline, not less. Which in the long term probably wouldn’t help the situation. It would be like making heroin cheaper for the addict. While initially it might increase gratification, it would just strengthen the dependency.
Somewhat disappointingly nobody has touched on the windfall taxes proposal. The problem with this idea is simple: it will reduce future oil production. Think prices are high now, enact a windfall profits tax and watch the oil production shrink in the future. Here is how to think about it. When an oil firm is thinking of drilling a well and pumping the oil they look at what revenues they expect to earn on that well in the future. As such they try to get an idea of what prices are going to be in the future. This will likely lead to a distribution from say $0.00/barrel (i.e. oil is considered worthless–a highly unlikely outcome) to say an equally highly unlikely outcome at the other end, say $200/barrel. The important thing isn’t the tails so much as the mean and probably the variance of this distribution. If the distribution has a low variance and the mean price is high enough then drilling the well and pumping might make quite a bit of sense. In the end, profit and more oil and gasoline. But a windfall profit that taxes away all the money per barrel over $40 would truncate the distribution (i.e. chop off the top portion). This would lower the mean which could very well mean that oil wells that would, absent the tax, be drilled wont be after the tax. Result, less oil and gasoline, and with increasing demand higher prices. So while the idea of a windfall profits tax might soung like a good idea (finally the consumer can stick it to the oil companies!), it would probably just make the situation worse for the consumer.
Also, as indicated above, finding a way to lower the prices might not be a good move. Lower prices will simply ensure that oil/gasoline are the main forms of energy. The higher prices will eventually lead to substitutes to oil/gasoline. Some people are looking at Exxon Mobil’s $8.4 billion profits (for the first quarter alone) and thinking, “It would be nice to find a way to get some of that!” And some of those people will start trying to figure a way to take some of that money. Take it by competing with Exxon Mobil. Lowering the price will blunt that incentive. Taxing away those profits will likely have the same impact. After all, if you come up with a really great solution to the high gasoline price such as a revolutionary new battery for hybrids what is to keep the government from taxing away your profits. The very same arguments of necessity that pertains to gasoline and oil could be used for such an invention.
This doesn’t mean we have to like the high oil/gasoline prices. I know I sure don’t, but try to find ways to use less. Using less means that is less money the oil companies and oil exporting countries get. It also, obviously, means more money in your pocket as well. It also doesn’t mean you have to like the oil companies. If it makes you feel better hate them for all I care. But the idea that we can some how force the gasoline prices lower, is somewhat of a pipe dream IMO. The former Soviet Union used force to run its economy..and that worked really well didn’t it.
1Note that the more vertical the supply curve the smaller the increase in production. If the supply curve is vertical (as it usually is in the very short run) then you’ll get no increase in production, but a price increase.
2One could argue that reducing consumption of foreign oil by consuming domestically produced oil is good for a variety of reasons. All I’m pointing out here is that there’d be little impact on prices.