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Tuesday, July 1, 2008

Whom Should We Thank for High Gas Prices?

Don't Direct Your Wrath at Big Oil

I am writing this after having just filled my tank with gasoline at $3.99 per gallon. Oil is over $125 a barrel. Big Oil and their CEOs are the hands-down favorite to win the Snidely Whiplash People’s Choice Award. Since Big Oil is our favorite villain, no one really wants to hear about the other deserving nominees in this category: Big Government and Big Green.

When Big Government calls for investigations to look into the “obscene profits” of Big Oil, this is always a crowd-pleaser. However, we rarely hear about the results of these investigations because they almost always implicate Big Government as the primary reason for the high prices and price spikes.

Another Big Government strategy to address high gas prices is to propose legislation that outlaws “greed” and “price gouging.” Big Oil has become the poster child for “free-market failure.” In reality, the petroleum industry, as it now exists, is anything but free market. A case could be made that it is one of the most regulated industries—if not the most regulated—in the United States. Decades of federal, state, and local government micromanagement of the petroleum industry have helped to create the mess we are in. The phrase “perfect storm” has been overused, but it helps to explain why we have gas at $3.99 a gallon. While “greed” is easy to understand, there are many interrelated facets of this problem that are not so easily understood.

The United States is no longer the primary customer for petroleum. Americans now have to compete for petroleum on the world market with people in the emerging economies of India and China. To no surprise, the Economics-101 concepts supply and demand come into play, driving up the cost of petroleum. What further complicates the situation is the weak U.S. dollar relative to other currencies. This helps to explain why oil is over $120 a barrel.

We could alleviate our supply problems by developing domestic sources of petroleum through privatization and free markets. The Arctic National Wildlife Refuge in Alaska has an estimated ten billion barrels of oil. Unfortunately, the Big Government/Big Green coalition has declared the reserve off-limits. The continental shelf could provide us with another 85 billion barrels of oil. But this plus the Florida and California coasts are off-limits because of environmental concerns.

The high price of gasoline now makes synthetic fuel derived from coal an attractive alternative or supplement to petroleum. The environmentalists are blocking it because it has an unacceptable carbon footprint. China, however, does not see this as a problem. The Chinese are spending billions to develop coal as a fuel.

If we can’t use domestic oil, what will the Big Government/Big Green coalition allow us to do? Their number one answer is “burn food.” But that pesky supply-and-demand issue keeps coming back to complicate things. Burning food in addition to eating it drives up the price. This is an inevitable outcome when you have people, livestock, and automobiles competing for limited supplies of food. If we continue down this ridiculous path, there is only one plausible outcome. We will have no choice but to develop more and more pristine wildlife habitat for agriculture. How long will Big Green allow that?

As it turns out, burning food as a fuel is not very efficient. Corn-derived ethanol yields 35 percent less energy than gasoline. So as the percentage of ethanol in gasoline goes up, miles per gallon will go down. Translation: Our demand for gas has gone and will continue to go up thanks to this government-promoted biofuel program.

We have not built a new oil refinery in the last 30 years, although existing ones have been expanded and updated. But 24 refineries have closed since 1995. For many of the marginal facilities, it was just too costly to comply with the burgeoning level of environmental regulations. Between 1994 and 2003 Big Oil spent $47.4 billion of their profits not to build new refineries, but rather to simply bring the remaining ones into environmental compliance.

To address the refining-capacity shortfall, there have been endless calls to build new refineries. This has become next to impossible because we now adhere to the BANANA philosophy. This stands for Build Absolutely Nothing Anywhere Near Anyone. BANANA has replaced NIMBY (Not In My Back Yard). According to the Tucson Citizen, a company in Arizona sought a permit in 1998 to build a refinery in Mobile, outside Phoenix. This would be the first new refinery built domestically since 1976. Five years later, the state of Arizona determined that the proposed location would not be in compliance with the ozone standards. The company then agreed to build the refinery near Yuma. Two years later, in 2005, the final permit was issued. This was seven years after the original request. Barring any further Big Government/Big Green roadblocks, we may have the first new U.S. refinery in 2011.

However, don’t expect a big rush to build many other new refineries. Through government biofuel and fuel-efficiency programs, the politicians have mandated a 20 percent reduction in our use of refined gasoline over the next ten years. Why would Big Oil increase the supply (by building more refineries) to meet a decreasing demand for gasoline? It should come as no surprise that many of the plans to build new refineries or to further expand existing ones have been put on hold. Government incentives and disincentives (in this case) really work.

Fewer Refineries Mean Fewer Options

Since building new refineries is not really a viable option for Big Oil, we are putting all of our eggs (gasoline production) into fewer and fewer refinery baskets. When the remaining refineries go offline due to accidents or routine maintenance, or to incorporate environmental changes, the impact on the entire nation’s fuel system could be both profound and immediate. Translation: price spikes.

Gasoline-price volatility is further exacerbated by government regulations that call for different types of gasoline in different parts of the country at different times of the year. We have winter gas and summer gas. There is Chicago gas and California gas. This means that entrepreneurs can’t readily move gasoline from where it is less scarce to where it is more scarce. We also still have the requirement for reformulated gas (RFG) in many areas even though the additive MTBE was determined to be dangerous to the environment. (Is that ironic? See my “Government-Reformulated Gas: Bad in More Ways than One,” The Freeman, September 2003,

As to be expected, the politicians’ “solutions” are nothing of the kind. Once again, some call for a windfall-profits tax. That’s a terrible idea on many levels, but suffice it to say here that it won’t raise supplies or lower prices. And what about the three-month gasoline-tax holiday being called for? It might bring prices down a bit—or it might not. And no doubt, the government will try to make up the revenue in other ways. All in all, the idea is an expedient, near-term, and unsatisfactory proposal. What we need is a long-term regulation holiday.

The next time you fill up your tank, don’t direct your wrath at Big Oil—they appear to be price takers. Direct it at Big Government and Big Green.

  • Michael Heberling is the Chair of Leadership Studies in the Baker College MBA program in Flint, Michigan. Prior to this, he was President of Baker's Center for Graduate Studies for 16 years. Before Baker, Dr. Heberling was a Senior Policy & Business Analyst with the Anteon Corporation. He also had a career in the Air Force retiring as a Lieutenant Colonel. Dr. Heberling has over 75 business and public policy publications. His research interests focus on leadership, military history and the impact of public policy on the business community. He is a member of the FEE Faculty Network.