- (Via Milinet)
06.30.2000
The Providence Journal
MACKUBIN THOMAS OWENS: Why gasoline prices have surged
DESPITE ASSURANCES earlier this year by Energy Secretary Bill
Richardson that
prices had peaked in the spring, the cost of gasoline has
continued to
escalate, especially in such Midwestern cities as Chicago and
Milwaukee.
When the price of a critically important commodity such as oil
rises rapidly
over a short period, there is an understandable desire to hold
producers
responsible. For instance, Vice President Al Gore and some of
his supporters
have blamed the recent spike in gasoline prices on "Big Oil" and
"price
gouging." Profits, they note, are up substantially.
But oil companies, big or small, are not the problem. Instead,
the
distortions that affect the U.S. energy market have been caused
primarily by
many of the same individuals who are pointing the finger at oil
companies:
politicians and bureaucrats.
Of course, oil companies are a favorite target of energy
demagogues. Indeed,
the charges leveled by the vice president conjure up images of
the 1970s -- de
ja vu all over again. But logic points away from the oil
companies as the
cause of recent price spikes. If oil companies can raise prices
at will, why
did they wait so long to do so? Why did they let energy prices
remain low for
the last two decades; indeed why did they permit them to fall to
record lows
last year? And why did they choose to "price gouge" primarily in
Chicago and
Milwaukee?
The fact is that three decades of investigations have never
produced a shred
of evidence to support the contention that oil companies have
colluded to
raise prices. It is clear that oil companies gain from higher
prices, but the
producer of any commodity is better off when the price of that
commodity
increases. And it shouldn't come as a surprise that oil company
profits are
higher now that crude oil is selling for over $30 a barrel than
they were
when oil was selling for $10 a barrel last year. The question
remains, of
course, what has caused the price of oil to rise?
The answer has two parts: first, market dynamics and second, the
unintended
consequences of environmental regulations. The market dynamics
are
straightforward: Demand has increased while supply has declined.
On the one
hand, U.S. demand for gasoline, already strong because of a
robust economy,
has surged as Americans take to the highways during the summer
vacation
season. American demand for gasoline appears to be inelastic --
a substantial
increase in price produces only a small decline in the quantity
demanded. The
reasons for this include the fact that demand is usually
inelastic in the
short run (consumers don't seek or can't find substitutes in the
short run);
and even with recent price increases, Americans spend a smaller
proportion of
their total wealth and income on energy than they used to.
So even if oil supply were unchanged, the increase in demand
would tend to
lead to higher prices for petroleum products. But supply has
been curtailed
as well. Oil-producing countries, led by members of the
Organization of
Petroleum Exporting Countries (OPEC), cut back production last
year after
crude-oil prices collapsed to record lows. Last week, OPEC
approved a small
increase in oil production -- 708,000 barrels a day -- bringing
OPEC's daily
production to 25.4 million barrels. But much of this new
production is
high-sulphur crude oil from the Middle East that does not meet
the clean-air
standards set by the Environmental Protection Agency (EPA). And
even if it
met EPA standards, it would not be enough of an increase to
offset the
increase in demand created by summer travel in the United
States.
But, ask the skeptics, why does gasoline cost so much more in
the Midwest
than elsewhere in the United States? Part of the answer has to
do with unique
regional problems of supply and refining capacity. But the more
significant
part of the answer has less to do with economics per se and more
with
politics -- the politics of environmentalism.
First, there have been problems with the pipelines supplying the
Midwest. One
was shut down for two weeks because of a fire in March. It is
now operating
at only 80 percent capacity for safety reasons. Meanwhile,
refining capacity
is tight because several important Midwest refiners were
temporarily off
line. Finally inventories were unusually low going into summer
because a cold
winter had increased demand for heating oil, which producers
continued to
refine instead of gasoline, and the rising price of crude
discouraged
restocking by refineries.
These factors were sufficient in and of themselves to cause
problems. But
they were further exacerbated by bureaucratic regulations and
micro-management. On June 1, just in time for the summer driving
season, the
EPA implemented stringent new clean air regulations mandating
the use of
"reformulated gasoline" (RFG) in certain areas of the country,
including
Chicago and Milwaukee, where gasoline prices have sky-rocketed.
Wisconsin and
Illinois are required by law to produce RFG with ethanol,
something that has
proven more difficult than anticipated.
As a result, RFG stocks are particularly tight, so prices are
higher in the
Midwest than in other parts of the country. So far, the EPA has
refused to
waive the requirement that gas stations sell only RFG in these
parts of the
Midwest. As a result, motorists in Chicago often drive to the
suburbs only a
few miles away, where they can buy conventional gasoline for 40
cents less
than the $2 a gallon that it would cost them to buy the RFG
mandated by the
EPA in the city.
Of course, clean air is an economic good, and it might be worth
the higher
cost of RFG -- if it actually worked. But a 1999 study by the
National
Academy of Sciences concludes that RFG is only moderately
effective in
reducing smog. It cuts some emissions while increasing others.
Meanwhile, a
recent Congressional Research Service report concludes that EPA
regulations
have increased gasoline prices in the Midwest by 50 cents a
gallon. The cost
of RFG seems high given the limited benefits.
If the EPA has its way, we can expect much more of the same in
the near
future. The agency is in the process of preparing new
regulations that will
further distort the motor fuel market, e.g., new standards for
sulphur
content in gasoline and diesel fuel. In promulgating these new
standards,
they are ignoring the warnings of refiners that they will
increase the cost
of refining and create supply problems.
Pending EPA regulations create more permanent and systemic
problems as well.
Because producers face the constant threat of additional
regulations,
incentives are distorted and investment in refining is reduced.
The Nobel
laureate Friedrich von Hayek once defined economics as "the
study of the
unintended consequences of human action." The
bureaucrat-generated
distortions of the U.S. gasoline market are a clear example of
exactly what
he had in mind.
Mackubin Thomas Owens, a monthly contributor, is a professor of
strategy and
force planning at the U.S. Naval War College. His e-mail address
is owensm@nwc
.navy.mil. The views here are his own and do not necessarily
reflect those of
the Defense Department or the Naval War College.
Copyright © 2000 The Providence Journal Company
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