Do gas giants charge too much?

Today Tanton and Dugan try to establish whether there is an appropriate price for a gallon of gas. Later they will debate regulatory and environmental issues related to fossil fuel use.

Short-term price shifts shouldn't change behavior

The Memorial Day weekend marked the official start of the summer driving season, and many motorists are complaining about the price of gasoline. Are current prices too high? How much higher will gasoline prices go? Will drivers change their behavior? Most importantly, what can or should be done about pump prices? To begin to get an understanding of these questions, we need to understand the factors that determine prices. Contrary to popular myth, the "big oil companies" actually have little to do with the price that consumers pay.

So, what determines the price? The majority of the pump price (at current prices, about 55%) comes from the price of crude oil. Petroleum is traded in a global market, just like agricultural products, minerals and steel. Prices for crude oil and products can be dramatically influenced by talk about future supply and demand, as well as the actual balance.

Foreign government-owned oil companies (not "Big Oil") own about 90% of the world's crude oil, and thus have the major impact on the price. Generally speaking, those government-owned companies, in countries with left-leaning governments, are poor performers in development and maintenance of their own oil resources. Those problems are not inherent in the commodity we call oil. They come from an inefficient and corrupt economic system: socialism. As a result, demand has outpaced supply, and oil prices have risen in America and around the globe.

Taxes account for about 20% of the pump price. Another 27% is for refining, transportation and marketing. Formulary requirements that differ from state to state and the national Renewable Fuel Standard (that requires ethanol blends) also cause upward pressure on pump prices.

The driving public is beginning to reduce consumption through changes in daily behavior, albeit only in small amounts. They are also shifting car-buying patterns to more efficient vehicles. The added cost and reduced performance of high-miles-per-gallon vehicles can only be justified if consumers expect that high prices will continue for the foreseeable future. Most consumers however, see that history is replete with price volatility—both upwards and downwards—and are choosing the short-term behavioral change rather than the longer-term investment change. There does not appear to be a "break-point" price at which consumers will dramatically reduce consumption. Even at today's price, gasoline is a small portion of people's budgets.

What should be done about high prices? First, we should begin by shunning punitive taxes that some want to slap on domestic oil companies, and the ill-conceived "anti-gouging" laws such as recently passed by the House of Representatives. Higher taxes would raise prices at the pump. Price controls—disguised as anti-gouging laws—would likely lead to gasoline lines such as we saw in the 1970s. A recent study by the Federal Trade Commission further identified government intervention, rather than free-market practices, as causing increased prices. More government involvement is not the answer. Expanded domestic petroleum exploration and development should be encouraged, not prohibited, as long as appropriate environmental protections are in place.

Thomas Tanton is the vice president and senior fellow at the Institute for Energy Research, and an environmental fellow at the Pacific Research Institute.
Regulation can work

First off, Tom, I agree with you on some major points. Yes, oil generally comes from unfriendly, inefficient foreign producers who set their own production quotas. I'd also agree that there are too many state formulas for gasoline. And that direct price controls are a bad idea—inefficient, easy to game and likely to create shortages.

But, bottom line: Gasoline Prices Are Too High and Oil Companies Are Loving It.

Those of us, including you, who saw the "market-based" rapacity of artificial electricity shortages in the 2000-2001 electricity crisis in California should smell a rat in the gasoline price spike.

The gap between the price of oil and the pump price of gasoline has grown dramatically from historic standards. This year, refining margins on a gallon of gasoline hit $1.00 a gallon, especially in California. That's more than twice the usual percentage of profit, despite lower overall oil prices.

The oil portion of the price of a gallon of gasoline dipped below 50% this spring, not the 55% that you cite or the 60% that oil companies used to quote.

If the gasoline business were competitive, producers would shrink their profit margins as the price of their raw material (crude oil) went up, in order to keep customers and grab more market share. But the few producers remaining from a decade of mega-mergers know they can all make more money on less gasoline. So they do.

It's the Supply

Yes, there's more demand for gasoline this year than the market is supplying. But it's not for lack of oil, which was backing up at the refinery doors this spring. Drilling in the Arctic wouldn't have helped a bit.

Producers shut their refineries for longer than usual maintenance. Prices went up. A raccoon bit through the power lines to a refinery. Prices went up. The truck carrying liquid nitrogen to flush a refinery pipe was late. Prices went up. All true, and the result of a deliberate industry-wide constriction of refining capacity over 20 years. The latest example was Shell's 2003 attempt to shut and demolish a profitable Bakersfield refinery.

As for those unresponsive consumers that you describe, Tom, how are they supposed to go cold turkey on gasoline when government skimps on public transit and fails to do something as simple as increasing automotive fuel efficiency? ("Go ahead and buy those SUVs, it's good for GM!"). Oil companies even today use their dealer contracts to keep gas station owners from offering renewable fuels.

Regulation Isn't a Commie Plot

Regulated utilities make a steady profit. Auto insurers have to open their books to justify their premium increases, and the market is both competitive and profitable. Regulation of the gasoline supply would not be any more disruptive.

As Ronald Reagan said, "Trust, but verify."

Judy Dugan is the research director for OilWatchdog.Org and the Foundation for Taxpayer and Consumer Rights.