May 21, 2006

Gas Prices

$3.00 a gallon for gas? Outrageous! Unthinkable! Who do we blame? It’s the Oil Companies! It’s taxes! It’s Hurricane Katrina! It’s global warming! It’s the war! It’s those @#$% arabs! It’s those @#$% Texans! It’s that @#$% Texan in the White House! It’s Peak Oil! It’s our consumerist society! It’s the worst problem we have ever faced! It’s not a problem! $3.00 a gallon? I wish it was $3.00 a gallon!

Seriously now, why are prices high and is that a bad thing? Well, first off, high compared to what? Compared to past prices in the US, prices are high but our friends in Europe are laughing their heads off at our present discomfort. They have “enjoyed” prices this high and higher for years. In fact even now, prices in Europe are almost double what we pay here. That is because of higher taxes there that not only raise money for government services but help shape public policy to reduce oil consumption. Cars are more efficient. Public transportation is better. Cities are designed so that people don’t need to go as far to work or shop as they do here. In fact, while some argue for a reduction in gas taxes to bring US prices down, a better case could be made for higher taxes, especially if the proceeds were used to increase efficiency and develop alternative energy sources that could help us make the transition away from oil.

In general, oil prices do not just reflect production costs. Of course, production costs are rising as cheaper sources are used up and replaced by more expensive sources. It should be obvious that cheaper, easier to get at oil is the first to be used. Eventually that gets used up and oil companies dig a little deeper and spend a little more to find new supplies. At some point it gets so expensive that other energy sources become cheaper and people switch over to them. People talking about Peak Oil are saying that we are reaching that point now. They say that we can look forward to declining production and increasing prices from here on out. Since our society is built around cheap oil we had better find a way to deal with this or we will face major problems.

In the long run, this is true. Right now, however, there are other factors that have a bigger influence on the current price spike. Oil prices are set by a kind of auction system with prices going as high as buyers are willing to pay. Contract prices are generally pegged to prices on commodity markets that work like the stock market. People decide what they will pay depending on whether they think prices will go up or down. People are speculating not only on current prices but on future prices as well. Disruptions, or the threat of disruptions will lead people to believe that prices will go up and therefore they are willing to pay more and so prices do go up. Lower supply and higher demand also drives prices up.

A similar system determines prices of refined gasoline, with a difference. The difference is that the major oil companies control the distribution system from refinery to gas station. Independent distributors are in a weaker position because they have to buy from the oil companies. We have seen Big Oil setting refinery prices high and taking a larger profit there while taking a smaller profit, or even a loss, at their own gas stations, undercutting the independents at the pump.

When refinery capacity is reduced, prices go up. This is what happened after Hurricane Katrina. But there have been reductions in capacity for other reasons as well. If a refinery goes down for maintenance it doesn’t have much effect but if several go down at once it can force prices up. I can’t help but be reminded of the electricity “crisis” of a few years ago during which so many power plants went out of service for routine maintenance that there was a serious shortage and prices went through the roof, leading to accusations of price manipulation and collusion. For many of us, that was the first, but not the last, we heard of Enron.

It is worth noting that some oil producing countries sell gas to their own citizens at very low prices. Venezuela, Nigeria, Saudi Arabia and Iraq under Saddam all have (had) prices well under $1.00/gallon. When Iraq was forced to switch to world market prices, it was a major problem for the economy and made life even more difficult for ordinary people trying to live a normal life.

The big winners from high prices are the big oil companies. Looking back over the past few years we see that every time there is a price spike, there is a corresponding profit spike. While higher prices can be a stimulus to a transition to other sources, quick price spikes are very harmful to consumers and to the economy. What it amounts to is a massive transfer of wealth from the rest of us to the oil companies.

Though not many people are willing to talk about it, this amounts to oil companies enriching themselves at the expense of human misery. Profiteering has always happened but it used to be condemned by society. When the war in Iraq started, oil prices reflected this insecurity in supply by rising sharply. The same thing happened after Hurricane Katrina. So, we saw people dying, others having a hard time making ends meet because of higher prices and a few oil company executives with millions of extra dollars in the bank. Is it surprising that they are nervous about trying to explain this to Congress?

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