May 11, 2006

NPR cuts through the crap behind "price gouging" claims on oil

Gas is indeed very expensive these days, and you might be wondering why... NPR has done an excellent analysis that explains the economics behind rising gas prices. If you're tempted to assert that companies are colluding or price gouging, read this first--you'll see that the chances of that are virtually nil. Among the most notable quotes:

"Oil companies don't set crude-oil prices; the global market does. Basically, the market decides what people are willing to pay at a certain moment in time."


"Oil companies, like the farmer, are the beneficiaries of high market prices, but they can no more control those prices than a farmer can dictate what he gets for a bushel of corn."


"Critics would say the oil industry is far less competitive than the corn market, which is certainly true. But if oil companies could control the price of crude oil, they would not have allowed the price to fall to $10 a barrel as it did in 1998."


"Countries like India and China are growing, and that has created more demand for oil and gas. In the United States, we're still going full throttle when it comes to energy use. At the same time, there have been supply disruptions and political instability in major oil-producing nations. So you have a situation where demand has been growing steadily and inexorably, and the system of supply is quite vulnerable. That's the basic recipe for high prices."


Keep in mind that the market goes both ways...
"If the market crashes to $1 per bushel, the farmer loses money. That can happen to oil companies as well."

Essentially, there are two solutions: a) increase supply and/or b) decrease demand. Americans certainly haven't been doing a good job on the latter.


7 comments:

  1. Anonymous1:11 AM

    I think there's also a third solution, but I'm not sure how big of an affect it would have.

    That solution is to apply uniform standards for gas across the country. Right now, each state determines what goes into their gas, what the standards for the gas is, and what the mix must be. This causes each state to rely upon it's own refinaries to produce the gas for the state, and if this supply is disrupted, prices go up quite quickly. Take California for example (it's where I live). Everytime there is a refinery fire, no matter where that refinery is, the gas price will almost immediately increase by 5 - 10 cents because the state cannot import gas from another state (like Arizona) to fill in the shortage. I've gotta think that that uncertainty is reflected in the price of gas. Plus, it makes the supply for the state limited to what it's own state can produce. Let all refineries produce the same mix for all states, and perhaps you increase supply.

    Also, gas taxes amount for a ridiculous amount of the price of gas. If the government really wanted to help people when gas prices are really high, they could cap the price at which their taxes would be in affect - when gas hits 3 bucks a gallon for the state, the taxes are no longer added. Or something to that affect. But since the states make so much money off of gas taxes, I can't see that happening.

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  2. Anonymous1:15 AM

    One more thing - the environmental standards imposed on gas also helped to raise the price. In California, the state decided that they wanted an environmental addititive inserted into gas to make it run cleaner (I believe this was the ill-fated MBTE). The gas companies all jumped at this opportunity, really confounding the legislature. But what they didn't get, but the oil companies did, was that by insisting on this additive, the oil companies could drive all of the smaller independent refineries out of the market because those refineries could not make the necessary changes to add the MBTE. And, once those refineries all closed down, the oil companies still around did not purchase them and they did not reopen them.

    Also, the environmental impacts really hinder opening new refineries to the point of making it impossible. More refineries = more gas, but getting the clearances and approvals from communities and environmental groups is so cost prohibitive that it's not worth it economically to the oil companies to try to get more refineries online.

    - Brian

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  3. Anonymous8:11 AM

    this doesn't make any sense. OPEC is a cartel - oligopoly, not perfect competition. Of course they have control over the price.

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  4. Uncertainly is certainly reflected in the price. Futures have definitely accounted for this as well and much of it is a reflection of how the market thinks the oil situation will be down the road (including factors on instability, demand, supply/etc).

    The suggestion to cap gas taxes when prices rise is not economically efficient. Setting a tax equal to the amount of marginal damage to internalize the negative gas externalities is the way to go, which unfortunately would have to be levied on the marginal gallon of gas. Not to disappoint, but the gas tax should actually be higher at this point to completely internalize the negative costs on others. There would be many benefits for using this tax instead of using fuel-efficiency standards and is supported by most economists as the win-win solution (look at Samwick's writing). Bush's former chair of the CEA, Gregory Mankiw, elaborates on the situation and makes a good case for the gas tax. After all, that would be the best way, right? Instead of telling people what to drive, or telling companies how to design their cars, the market makes the optimal amount of gasoline consumption happen because of this basic principle: you can drive whatever the heck you want, but you pay for it--all of it, including the negative costs imposed on others.

    As for MTBE, yeah what a mistake. See, this is the beauty of a gas tax. Remove all ethanol subsidies, remove environmental standard requirements. Simply calculate the amount of damage caused per gallon of gas and make sure people pay for it (yes it will mean that the gas tax will be higher). But, it means none of the state-regulation problems as we've seen. This does have to be done with an efficient pigouvian tax though.

    As for OPEC and it's cartel power, the truth is that it is much weaker than people realize. Of the top-5 oil producers, only 2 are part of OPEC. Even if OPEC actually acted as an effective cartel, it would only account for 40% of the world's current production, meaning that the probability for it to dictate prices is limited because there is still so much production by other countries. Furthermore, they usually fall in-line with what game theory predicts: each OPEC member has an incentive to cheat in order to take advantage of higher prices. This is indeed exactly what happens time after time again, which is why OPEC countries currently have little, if any, spare production capacity--because they have not been able to follow their own quotas. Fortunately, the world benefits from this, however, because OPEC's attempts to set prices are driven back. Thus, the assertion that OPEC is an oligopoly that can control prices is only correct if it is effective--a look at the numbers says they aren't.

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  5. Anonymous1:29 PM

    A couple of things that I got from my dad (he used to work in the oil industry as a lobbyist):

    If we eliminated the different environmental standards placed on gas by the differing states, gas prices would drop 10 - 15 cents. Not bad. And drop ethanol - it's actually a negative draw. It costs more fuel to harvest corn than it saves. And they get massive subsidies. Cut it.

    We won't be seeing more refineries anytime soon for two reasons. First, it takes around ten years to gain approval to build one. And second, why would an oil company want to invest in a refinery when everyone is working on coming up with an alternative to that fuel?

    And finally, for the most ridiculous thing of all time, California calculates its sales tax for gas not on the base price of gas, but on the price of gas after the fixed federal and state taxes have been added. They're taxing a tax. The most ridiculous tax of all time. More ridiculous than the Estate Tax, but we'll leave that for another discussion.

    - Brian

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  6. Anonymous8:35 PM

    In addition to removing the subsidy on ethanol to encourage competition among ethanol manufacturers, we should remove the tariff on imported ethanol, which keeps out more fuel-efficient (by, from some numbers I've seen, 30-50%), cheaper (by about 50%) Brazilian sugar-based ethanol.

    That still doesn't solve ethanol's negative environmental impacts: while it does emit less carbon monoxide than gasoline, it increases the concentrations of ground-level ozone, nitrous oxide, and volatile organic compounds.

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  7. Anonymous10:36 AM

    How's about we just stop driving cars so much. Move to a goddamn city, ride the subway, and go to some museums.

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