Thoughts on Gas Prices

It certainly is painful to have to spend about $3.50 a gallon to keep my vehicles running. The only upside is our recent purchase of a used Volvo wagon that seems to get about twice the mileage of the Dodge Grand Caravan it replaced.

In the meantime, it is rather interesting to hear all the angry conspiracy folks, most of whom think the gas prices are simply a result of George Bush and Dick Cheney making it so for their own greedy and rapacious reasons.

Being the sort of person that prefers to do my own studying on such issues, I find the causes of our collective misery to be multifaceted, but not all that difficult to understand.

The fundamentals governing gas prices are simple macroeconomics. I hated the courses in graduate school, and suspected much of the drivel we studied existed only to keep that professorial class of people called Economists employed.

The supply of oil, or the raw material that goes into the gasoline we need to make our cars run, is controlled by a small group of people. That group is controlled by sheiks and mullahs, with a few communist and totalitarian dictators thrown in. Their paradox is a shared hatred for America coupled with the fact that America is their biggest customer. Through a cartel they formed in the 70's called OPEC, they can and do restrict the amount of oil that is made available to the world market. Over the last 40 years, this has made them among the richest individuals on the planet.

Contrary to popular belief, the price of crude oil is not set by Dick Cheney. Nor is it set by OPEC. It is set by the worldwide market. The world comes to the OPEC producers with cash in hand to bid against each other for the oil they must have to fuel their economies. Places like China and India have become major players in this bidding process, helping drive up the prices.

Then the big, bad oil companies come into the picture. They're the guys daily portrayed by the mediademocrats (who have now become permanently attached) as evil profiteers who take billions in obscene profits from the poor American consumer.

The oil companies take the crude oil to their refineries, where they produce the various kinds of gasolines that power our vehicles. There hasn't been a new refinery built in the United States in over 40 years, so those existing refineries run at 100% of capacity in an attempt to keep up with demand. If a refinery has an accident, fire, or breakdown and fall behind in their production schedule, shortages ensue. Shortages mean higher prices, of course.

So let's get to the root causes of high prices at the pump.

Supply is controlled by a small number of people, most of whom don't much like America.

America has vast untapped oilfields in places like Alaska and the Gulf of Mexico that could alleviate the crude oil supply problem. But environmental regulations refuse to permit anyone (certainly not American oil companies) to drill for that oil. The ANWR preserve in Alaska is a vast oilfield that cannot be tapped because of specious arguments from environmentalists that somehow extracting the oil will harm animal habitats. The Gulf of Mexico also has vast reserves, but the same environmental interests shut down drilling there out of a fear of accidental leaks. In the meantime, Mexico is actively exploiting those very oil fields as we watch helplessly.

America has lost most of its manufacturing base to China and other developing countries, where demand for oil to fuel their growing economies is expanding exponentially.

Taxes are stiff on each gallon of gasoline. These taxes are collected by both the Federal and State governments, averaging 42 cents per gallon. In some states, the total tax per gallon is well over 50 cents per gallon. These taxes were sold to the American people as a means to fund road construction and maintenance. However, in most states and the Federal Government, they just get thrown into the General Fund to be spent in whatever way lawmakers deem best to keep their seats.

Refinery capacity is certainly a contributing factor. Environmental regulation makes it all but impossible to build a new refinery in the US. The cost of building a new refinery, including the costs of satisfying environmental requirements, is deemed by the industry to be a bad investment. Besides, given the unprecedented profit margins in the industry today, they have no incentive to aggressively pursue permits for new refineries.

It is arguable that the current administration has no desire to enforce anti-trust law. The oil companies have consolidated into a very small number of gargantuan global megacorporations. So if a crusading government decided to pursue those companies based on anti-trust violations, what is the most likely outcome? Those oil companies still headquartered in the United States will simply pack up and move to a country that promises to be more friendly to their interests.

So what's the answer? Most politicians say it's alternative fuels. Ethanol plants are springing up all over the place, and car manufacturers are now building new vehicles that can run on Ethanol. But most other alternative fuels, such as hydrogen cells and electric batteries, are nowhere near ready to become viable competitors.

The basic problem with alternative fuels is this: Let's say that an alternative fuel can be produced at the cost of, say, $1 a gallon. By the time it's gone through the distrubution process, the retail price becomes about $2.50 a gallon. Add in the government's tax burden, and you're selling this alternate fuel for between $2.90 and $3.10.

So the OPEC guys and the Oil companies see this happening, and don't want to lose their market share. So they boost production and get the price of gasoline at the pump down under $2.50, including taxes. They can do this easily, because gas prices are based on market demand, not on production costs.

They have now succeeded in substantially undercutting the competition, which does not have the luxury of matching the competitor's prices. The producers of alternative fuels go out of business. Shortly thereafter, OPEC and the oil companies restrict supply and get the gas prices back up, maybe to $4 or $5 this time.

No, the problem can't be solved by government. It can only be marginally ameliorated through encouraging competition in terms of oil company start-ups, opening up ANWR and the Gulf and other promising sources of crude oil, and giving tax incentives to producers and researchers developing alternative fuel sources.