Why gas prices are so high? If you watch TV or read the newspapers, you would think that oil company executives are smoking cigars, laughing in their ivory towers about the billions of dollars in profits they are squeezing out of Americans with every gallon of gas pumped. I came across a FANTASTIC article that explains in plain English the things I have been wrapping my head around from an economics enthusiast’s perspective. Should you not have the time to follow the link and read the entire article (it would take about 20 minutes or so), I have highlighted some of the most important points below.
Oil is not the only commodity that is becoming more and more expensive to buy. The cost of food is also going up. So is the cost of just about everything else. One major reason for this overall rise in prices is because the dollar does not buy as much as it used to. And the reason the dollar does not buy as much as it used to is because the Federal Reserve System (along with the U.S. Treasury Department) is inundating our economy with newly created dollars. Their intent is to finance the federal government’s massive expenditures as well as to prevent a deepening recession. The newly created dollars won’t solve our economic problems, of course, since each new dollar added to the economy devalues the dollars already in circulation, causing prices to rise.
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But inflation, though hugely important, is not the only factor. To be sure, the price of gasoline is heavily dependent on the price of crude oil, which like any other commodity is affected by supply and demand. Either an increase in demand or a drop in supply (or both at once) will cause prices to rise. Rising prices also encourage more production and discourage wasteful usage.
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Tragically, our dependence on foreign oil is not only dangerous but unnecessary. America has abundant energy resources, including oil reserves that remain largely untapped. For example, significant untapped reserves exist in the Gulf of Mexico, off both our Pacific and Atlantic coasts, and both on land and offshore in and around Alaska. According to API, “The U.S. government estimates that deepwater regions of the Gulf of Mexico may contain 71 billion barrels of oil.” API estimates that there are 10.5 billion barrels off the shores of California and the Pacific Northwest, 3.8 billion barrels off the Atlantic coastline, and 18 billion barrels onshore and 26.6 billion barrels off the Alaska coast and in the Alaska National Wildlife Refuge (ANWR). This adds up to 138.1 billion barrels of oil, enough to power over 60 million automobiles for 60 years according to government estimates.
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What domestic oil we are able legally to remove from the ground must of course be refined, and here, too, environmentalist groups and environmental regulations have hamstrung the oil industry — to the extent that not a single major new refinery has been built on U.S. soil since 1976. How limited is our refinery capacity? Hurricane Rita answered that question when she stormed through the Gulf of Mexico in late summer 2005. Although Katrina received more press coverage, having devastated New Orleans a few weeks earlier, Rita actually did more to disrupt the process that supplies gasoline to millions of American consumers. Rita damaged a number of major refineries along the Texas coastline, temporarily affecting supply and causing a spike in prices. For the first time, we saw gas prices increase to over $3 per gallon; this happened in less than 24 hours. As the refineries were repaired and supplies were restored, however, prices retreated.
Some states, moreover, have passed restrictive laws resulting in higher prices for consumers. California is an example. The State of California operates its own reformulated gasoline program, calling for special oxygenated, reformulated, and low-volatility gasolines to reduce toxic emissions. These cost more to produce than conventional gasoline. In other words, California state law is stricter than what the federal government requires. In addition to the added costs of the additional refinement, California imposes a combined state and local sales and use tax of 7.25 percent on top of an 18.4 cent-per-gallon federal excise tax and an 18 cent-per-gallon state excise tax. California’s refineries must run at or near full capacity at all times to meet the state’s fuel requirements. If more than one refinery experiences operating difficulties, the result will be supply problems and a spike in gas prices in the state. There are relatively few suppliers of the unique blend of gasoline required by California state law.
Taxes added by federal, state, and even local governments do contribute to higher gas prices elsewhere. We just noted how federal excise taxes account for 18.4 cents per gallon of gas. State excise taxes account, on the average, for another 21 cents per gallon. Eleven other states add additional state sales and other taxes. This does not account for local city and county taxes which can also impact significantly on the cost of a gallon of gasoline, varying from location to location.
Though the aforementioned cost factors may seem to contradict the reasons given in mainstream media behind rising gas prices — i.e., that malicious unregulated oil speculation (buying oil futures, betting prices will rise) is driving up gas prices — they are not contradictory. Speculators purchase futures contracts, hoping to sell the contracts in the future for a higher price, thereby making a profit. But even in unregulated markets, commodities prices can only continue higher as long as commodity supplies remain low. When high prices cause a commodity glut, prices drop or stay stable. In the case of oil, high oil demand, along with tight oil supplies and huge government infusions of new cash into the markets (which prompt increased speculation), are driving oil prices up. The speculators are not evil; they are responding to market forces.
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Oil and natural-gas revenues are large; there is no question about that. But so are the industries themselves, and so are the costs involved in providing fuel to consumers. Oil company profits allow for reinvestment in facilities, technology, and infrastructure. Reports on oil company profits can be misleading because they focus exclusively on earnings and don’t take into account the size of the operations. Earnings alone, therefore, do not tell the whole story. Relative to other major industries, oil company profits are about average, at 8.3 cents for every dollar of sales, compared to the chemical industry’s 12.7 cents for every dollar of sales, the computer industry’s 13.7 cents and the pharmaceutical industry’s 18.4 cents for every dollar of sales.
Some politicians would like to see a new era of “windfall profits” taxes on oil companies. Their contention, based on the illusion of earnings figures alone, would clearly do more harm than good to an industry they do not understand. By and large, America’s oil companies aren’t owned by the small groups of insiders that control political parties. The percentage of industry shares owned by oil executives is only around 1.5. The rest is owned, indirectly, by tens of millions of American shareholders, often through their mutual funds, IRAs, or other personal retirement accounts, most of which invest in oil and natural gas stocks. If politicians were to institute a “windfall profits” tax or — worse yet — attempt to nationalize the oil and natural gas industries under the belief that this would get prices under control, who would really be hurt? The answer: these millions of ordinary investors with mutual funds, IRAs, or other personal retirement accounts.
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At present, the reality is that our economy is dependent on oil and will remain so for at least another generation. Thus our short-term goal should be to do what we can to ensure that the cost of both producing oil and refining it into gasoline is contained, so that gasoline remains affordable to American consumers. Congressman Ron Paul (R-Texas) has introduced new legislation, H.R. 2415, the Affordable Gas Price Act. The bill states its own purpose: “To reduce the price of gasoline by allowing for offshore drilling, eliminating Federal obstacles to constructing refineries and providing incentives for investment in refineries, suspending Federal fuel taxes when gasoline prices reach a benchmark amount, and promoting free trade.”
With this last, Dr. Paul means real free trade, not the managed, pseudo-free trade of NAFTA, CAFTA, and the like. The point is, the federal government has proven to be the biggest obstacle to our achieving energy independence and thus containing the alarming escalation of gas prices. Environmental groups may run a close second, but their influence is felt through legislation passed by Congress.
Wow… Getting rid of multiple blends that are demanded by the anti-capitalists, increasing refining capacity by building more refineries, and drilling domestically for oil until the free market provides alternatives to fossil fuels. That sounds a lot like what I have been saying for a while now.
H/T: Pax Hammericana for the link
