Gas prices
Frosty
By Robert P. Murphy
Posted on 5/25/2007
On Wednesday the House passed a bill that would make price gouging by
oil and gas companies a federal crime. The legislation called for jail
time and fines of up to $150 million a day for charging
"unconscionably excessive prices" and taking "unfair advantage" of
consumers.
As frequent readers of this website already know, this proposed
legislation is horrendous and would do nothing to help the American
motorist. In this short piece I'll outline some of the major problems.
VAGUE LANGUAGE
The most obvious difficulty is the arbitrariness of the "crime." Say
what you will about outright price controls, at least they're
explicit. In contrast, how's the owner of a gasoline station supposed
to know if he's charging "unconscionably excessive" prices? After all,
if he's taken a basic economics course, he might think that any
market-determined price is quite reasonable. If this bill becomes law,
sellers here will be at the mercy of the FTC the way drivers are at
the mercy of traffic cops — you can always get written up for
something.
While we're at it, let's just spend a moment on the wording of this
bill. Why isn't it a crime to merely charge "somewhat excessive"
prices — though perhaps not receiving the same penalty as
unconscionably excessive ones? (After all, it's a crime to murder
someone, but it's also a crime to punch someone in the face.) Come to
think of it, shouldn't we also punish unconscionably low prices —
after all, they're unconscionable by definition! And if you can't
imagine what that would mean, maybe an unconscionably low price is one
where mom and pop gasoline stations can't stay in business. (You know,
kind of like unconscionably cheap imports from China that we have to
keep out for reasons of "fair trade.")
And let's not forget the other clause, taking "unfair advantage" of
the consumer. Shouldn't it also be a crime to take "fair advantage" of
the consumer? (After all, you're still taking advantage of the
consumer in this case.)
My point, of course, it that this language refers not to objective
behavior, but merely reflects arbitrary subjective judgments on the
part of the government official meting out the punishments. Adding on
a layer of uncertainty and vague threats of massive fines and possibly
jail time won't increase the supply of gasoline, and hence won't help
motorists.
WHY ARE PRICES SO HIGH?
Before using the guns of the federal government to try to force them
down, people ought to first consider why it is that gasoline prices
are so high. The usual explanation — "The oil companies are greedy and
want to screw over the hapless drivers!" — makes no sense. After all,
oil companies were greedy during the whole 1980s, when the price of a
barrel collapsed to under $11 (in nominal terms) in July 1986. And
automobiles weren't invented in the last three years, so it's not as
if the US "addiction" is something new.
The general causes for high oil prices are pretty straightforward:
Supply is restricted because of the mess in the Middle East (not to
mention environmental and other regulations), while demand is booming
as China and other developing countries grow much more quickly than
people had anticipated years ago (when oil infrastructure decisions
were made). On top of these "real" factors, the general uncertainty
about the Middle East — especially the possibility of war with Iran —
has caused speculators to push up the price even higher.
Now high oil prices explain gasoline prices in part; if oranges are
really expensive, you can bet that orange juice won't be cheap. But
what is particularly strange is that oil prices are actually a lot
lower than they were just last July ($64 and change as of this
writing, compared to highs of $78 in July), yet prices at the pump are
at all time (inflation-adjusted) highs.
The immediate answer is that refineries can't keep up. (If there were
a major strike at Tropicana packaging plants, then the price of orange
juice would be higher still, than would be justified by higher orange
prices.) There are all sorts of reasons people have given, such as the
lingering effects of Katrina, new environmental regulations about
diesel fuel, restrictions on new refinery construction, and so on.
PRICE CAPS CAUSE SHORTAGES
But regardless of the specifics, the thing to remember is that market
prices are not arbitrary. The market price is the one that (tends to)
equate quantity demanded with quantity supplied. If a gas station can
charge "whatever the market will bear" at $3.15 per gallon, but only
charges $2.85 out of fear of fines, then it automatically follows that
this gas station will have to sell people fewer gallons than they want
to buy at the lower price. In other words, the proposed legislation
will cause dreaded shortages of gasoline.
The only thing I've "assumed" to reach this conclusion is that people
buy more gasoline at lower prices. If you grant me that, then you have
to admit that government efforts to reduce prices below their market
levels will cause shortages, and that means (as in the 1970s when the
great Republican Nixon imposed price controls) long lines at the pump
and arbitrary rationing schemes.
This is an important point so let's make sure we follow it: The market
price is the one that matches supply with demand; it's the one where
gas stations want to sell the same amount of gallons that motorists
want to buy. So if the government forces the gas stations to lower
this price, then motorists want to buy more gallons than they would
have at the higher price. So unless you think a gas station owner
would be willing to sell certain stockpiles of gas for (say) $2.50,
but he wouldn't want to sell them at (say) $3.15, you have to admit
that this legislation will lead to lines at the pump.
Incidentally, this isn't academic speculation. This is exactly what
happened during the hurricane season, when people in the Gulf states
tried to flee to safety. Certain gas stations (out of fear of
punishment or perhaps misguided altruism) didn't raise their prices,
even though their business was astronomical (since everyone was headed
for the highways). The result? These gas stations got drained fairly
quickly, and consequently many of the fleeing motorists ran out of gas
and were stranded on the interstates.
TAKE IT TO THE LOGICAL EXTREME
"But regardless of the specifics, the thing to remember is that market
prices are not arbitrary."
I'll wrap up this article with a simple question: If all it takes is a
stroke of the pen for Congress to magically lower gas prices back to
"conscionable" levels, why not go further? Why not make it a crime to
charge "moderate" prices too, so that we're left with very cheap
gasoline? Woo hoo, break out the SUVs!
Once you think through the logic of why a government-imposed cap of
(say) 25 cents per gallon wouldn't work, it's not much harder to see
why a cap of $3 would be bad too.
The reason for high prices is increased scarcity. The way to solve
that is to make it worthwhile for producers to increase supplies. No
one in his right mind would spend billions looking for new oil fields,
laying pipelines, hiring geologists, etc. if it looks like Congress
might tax "windfall profits," impose price controls, or artificially
stimulate demand for a competitor's products.
The oil industry involves long time horizons, and investors don't want
to be exposed to a fickle public. Property rights serve a purpose,
after all.
The solution to high oil and gas prices is to get the government out
of the way. Ease restrictions on new refineries and oil drilling, get
rid of taxes on gasoline, and stop threatening to nuke Iran. That
would solve the "crisis" very quickly.