Econ 101 vs. the Politicians

Dennis Schiffel

The news media are busily reporting the comments of elected officials about gas prices. Frequently, neither the media nor the politicians’ comments make any sense. Let’s look at a few of those comments.

Nevada Senator Harry Reid charges greedy oil companies are gouging consumers. Unfortunately, this kind of political statement panders to public misperceptions. And rather than educate the public, or identify underlying causes and workable solutions, it just seeks to blame someone.

Senator John Kerry proclaims President George W. Bush could and should do more to pressure OPEC, especially the Saudis, to pump more oil. The U.S. and the G-7 nations are doing so. But it doesn’t matter. There is precious little pressure to bring. And, history shows the Saudis act in their own interest.  

Senator Charles Schumer and others argue we should release oil from the Strategic Petroleum Reserve to ease gasoline prices. Historical evidence shows that won’t work: President Clinton tried it, and prices at the pump dropped only a few cents for a few weeks before going back up.

The Strategic Petroleum Reserve was established to provide a reserve in case of national emergency caused by war or interruption of oil supplies to the U.S. It was not established to manage prices at the pump. But that’s not the whole story. OPEC and members of the 26-nation International Energy Agency have an informal agreement: If the consuming nations do not tap their strategic petroleum reserves, OPEC will assure adequate supplies of oil. If that agreement is broken, what will OPEC do?

Some may recall the long gas lines a quarter-century ago. Today it is generally agreed that there was no fuel shortage. The problem was the government thought there was a shortage, intervened with controls and caused a shortage. The current Republican-sponsored energy bill before the U.S. Congress will be expensive and largely ineffective because it involves no fundamental changes. “The energy Bill is the worst case of pork barreling and vote buying I have seen,” says Senator John McCain. Among other things, the initial bill includes a subsidy of $18 billion for a natural gas pipeline, a doubling of economically inefficient and environmentally unfriendly ethanol production and funds for an artificial rainforest in Iowa. Perhaps we should hope that politicians continue to talk, rather than act.

It is distressing how few politicians, as judged by their remarks, understand economics or the workings of industries they criticize. They apparently didn’t take—or failed—Economics 101, in which supply, demand, the price system and resource allocation are taught. Rather than face facts about high prices, it is much easier to blame some evildoer in the private sector or some politician of the other party instead of sorting things out and offering intelligent solutions.

The facts are: (1) Energy prices are set by supply and demand. (2) Supply and demand need time to adjust to new circumstances. (3) The U.S. has few short-term options for dealing with high energy prices—and those it has are mostly inconsequential. (4) Many politicians won’t deal with energy price fundamentals. (5) The history of oil prices is that they oscillate, up and down. (6) Media talking heads and others almost always overstate how high or low prices will go.

Let’s just note a few of the factors that recently have driven up fuel prices. A major dynamic is the increase in world demand for oil that has surprised industry participants and expert observers. Higher demand drives up prices, other things equal.

Speculation driven by concerns over the situations in Venezuela, Nigeria, Iraq and the Middle East in general is estimated to levy a $5-to-$10 premium per barrel. That is, the underlying price of oil, stripped of these effects, would run $30-35 per barrel, rather than hover around $40.

Refining capacity in the U.S. is limited. While existing refineries have been updated and their capacity increased over the past 20 years, no new major refineries have been built. Still standing in the way are required permits, environmental concerns and low returns on new construction. This constraint on supply drives up prices.

Boutique gasolines, unique to individual states or regions, create potential supply disruptions as well as constraining supply and raising the price of gasoline.

Finally, the public often wants contradictory things—big gas-guzzling vehicles, low-priced abundant gasoline, independence from foreign supplies, high hurdles for refinery investments, no foreign policy adventures tied to oil supplies, and restrictions on domestic exploration.

It’s too bad we can’t have everything.

Dennis Schiffel is a former senior associate at the National Science Foundation and a policy fellow of the Nevada Policy Research Institute.