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The Oil Follies

Mises Daily: Tuesday, June 24, 2008 by

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A recent poll taken by CNN found that US drivers fear the possibilities of shortages more than they fear higher prices:

A CNN/Opinion Research poll released Tuesday shows that 55% of those surveyed are more worried about long lines at gas stations and rationing than about the high prices that drivers have paid in recent months. The poll shows 40% of the respondents are more concerned about the high prices.

While gas rationing is not expected at this time, it was a hallmark of the 1970s-era energy crisis, when drivers lined up outside gas stations and sales of gas were limited to certain days of the week.

However, at that time, gas was in short supply, which is not the case today.

Meanwhile, Congress has been stopped in an attempt to create the very thing that motorists fear most. Among the things that were in the bill that has been successfully filibustered by the Republicans:

The windfall profits bill would have imposed a 25 percent tax on profits over what would be determined "reasonable" when compared to profits several years ago. The oil companies could have avoided the tax if they invested the money in alternative energy projects or refinery expansion. It also would have rescinded oil company tax breaks — worth $17 billion over the next 10 years — with the revenue to be used for tax incentives to producers of wind, solar and other alternative energy sources as well as for energy conservation.

The legislation also would:

  • Require traders to put up more collateral in the energy futures markets and open the way for federal regulation of traders who are based in the United States but use foreign trading platforms. The measures are designed to reduce market speculation.

  • Make oil and gas price gouging a federal crime, with stiff penalties of up to $5 million during a presidentially declared energy emergency.

  • Authorize the Justice Department to bring charges of price fixing against countries that belong to the OPEC oil cartel

Anyone familiar with modern politics knows that Republicans and Democrats regularly vie with each other to see who can be more economically illiterate, but it seems that with this proposed legislation, Democrats are determined to take the lead and cripple the US oil industry permanently. It is a shame that for all the years Republicans controlled both houses of Congress and the White House they could not come up with any decent energy-based legislation, but at least we can now be thankful for small favors that Republicans seem to have "discovered" the evils of federal regulation of oil markets.

Instead of looking at this situation squarely and putting together the obvious pieces, it seems that the political classes in this country have decided that supply and demand really don't matter at all, and that all commodity prices are simply arbitrarily administered by people who are impervious to the desires of consumers. Such a view permits the political classes to ride in as heroes. However, in this story, instead of saving the town from the bad guys, the "heroes" burn it down and then claim to be liberators.

In examining the latest follies from Washington, let me emphasize again that it is not Republican versus Democrat, although that might be the assumption from the latest oil votes. If the Republicans really believed that free markets were the best way to produce and sell oil and gasoline, then they would have pushed — and passed — legislation that would have made it easier for energy firms to produce. They did not, and one wonders if the whole episode of the successful filibuster was just one more cynical political ploy that both parties do as a matter of course.

That being said, I still wish to fully examine the filibustered legislation to demonstrate just how destructive it would have been had it become law. Thus, I look at each of the particulars and explain why they were so bad.

The "Windfall Profits" Tax

It is hard to believe that legislation that was a failure nearly three decades ago would be trotted out now as a "fix" for higher prices. Legislators are angry that oil companies are making large profits during a time when gasoline prices are very high, but this has been the usual response whenever prices increase, and this situation is no exception.

I have written before on the subject of high prices and high profits. Politicians insist that the causality chain runs from profits to prices when, in reality, it is the other way around. Oil companies are making large profits because they purchased the factors of production at relatively low prices and are able to sell their products for more than the company managers and the factor owners projected at the time of the agreement to sell.

However, record profits also mean better opportunities for recapitalization and new exploration. If executives are not investing many of their profits into exploration and new equipment, then it means that they do not have confidence in the future. This would not be because oil suddenly will be unprofitable, but rather because oil executives have no confidence in the political classes.

Indeed, the prospect of a huge tax on profits — a tax that would be levied specifically at one industry on top of other taxes the oil industry pays — means that if oil companies are successful at their endeavors, Congress will single them out for special punishment. Congress wants to do what dictators have always done: steal the property of people who cannot defend themselves against the encroachment of the state. Thus, by threatening to confiscate the oil profits, Congress is encouraging the industry not to invest in new capital and not to increase oil supplies.

This is no idle threat. The Mexican national oil company, PEMEX, which came from "nationalized" oil firms, is woefully undercapitalized, as oil profits have been spent on political favors and other things that have ensured that old equipment will not be replaced. It also means that PEMEX does not have the capital to explore many of the vast oil regions of the Gulf of Mexico, which means the firm is missing out on many opportunities.

Indeed, the spate of nationalization that occurred during the 1950s and beyond has meant that oil production is lower than it could have been had private companies been left alone. Unfortunately, in this politicized age, private production has been equated with "exploitation," which means that socialist firms will continue to dominate the oil business.

Regulation of Futures Markets in Oil

Not surprisingly, Congress has joined the ancient chorus of "blame the speculators." Yes, we are supposed to believe that after years of suffering under $20-a-barrel prices, the evil speculators suddenly conspired to jack up the price of oil.

Far from being "faceless" villains, the "speculators" are people purchasing future contracts for oil (and other commodities) to ensure that they will have supplies in the future. They represent firms that purchase gasoline and oil contracts and they have no interest in jacking up the price for its own sake. As economist Walter Williams has written,

The futures market, which takes into account both the present and the future availability of goods, is a vital part of a smoothly functioning economy. Unfortunately, that fact provides little comfort to people frustrated over the high prices of food and fuel. As such, it provides fodder for political demagogues, charlatans and quacks who rush in with blame and prepare "solutions" for the problems they themselves have created — the high prices for food and fuel are directly linked to the policies of the White House and Congress.

Government regulation of the futures markets in oil would simply make the markets more chaotic, less predictable, and would guarantee prices that would be higher in the absence of a free-flowing market. (Yes, yes, government regulators claim that they will make the markets more "fair" and predictable, but we know how specious those claims really are.)

Criminalizing Higher Oil and Gasoline Prices

When in doubt, Congress makes something a crime. Keep in mind that while they are first speaking of $5 million fines, ultimately they will be throwing people in prison for "economic crimes," and "speculation," which was the hallmark of the former Soviet Union.

Furthermore, "the power to declare an economic emergency" is a nice euphemism for dictatorship. The Congress — which claims that it really does believe in separation of powers — wants to endow the president of the United States with the power to declare "economic emergencies," and if people afterward raise the prices of oil (or, most likely, anything else), they will ultimately be fined into bankruptcy or thrown into prison.

These are draconian price controls, only a little bit below the declarations of the Roman Emperor Diocletian, who pronounced the death penalty for anyone who violated his orders on price controls. I would suppose it is progress that the Democrats in Congress only want to imprison but not execute anyone who disobeys the president's edicts on price controls, but somehow I do not think this is a hopeful trend.

The price controls during the 1970s were the fundamental cause of the huge gasoline shortages that consumers today are fearing. Those of us who braved the gas lines of the 1970s also remember the horrible rhetoric that came from Congress and from President Jimmy Carter, who constantly railed against the oil companies and pushed his own "windfall profits tax" through an eager Congress. (The tax was ultimately repealed in the 1980s, but only after doing substantial damage to the oil industry. After the tax was repealed, oil and gasoline prices fell.)

Congress is now demanding the same conditions as were experienced in the 1970s, and when the inevitable gasoline lines appear with the inevitable shortages, they will then bring oil executives before Congress to be pilloried, attacked, and almost certainly charged with federal crimes that will land them in prison for many years. At that point, there really will be little difference between the government of the United States and the government of the Soviet Union.

Sue OPEC

When in doubt, enrich the trial lawyers, who make up one of the most important constituencies for the Democratic Party. One can only imagine what would happen if the US government sued OPEC nations in US federal courts. First, they would be true kangaroo courts, as one can imagine that US juries would dutifully bring judgments against Libya, Saudi Arabia, Venezuela, and other countries.

That the entire thing would be a farce is another matter. Despite how all the Democrats and others in the political classes decry the loss of respect the US government now receives because of its global wars, one cannot imagine how badly such legal action would tarnish what is left of the US reputation. The most important thing, of course, is that such litigation would only make oil more costly and further aggravate international resentment of US meddling.

Economic illiteracy has always been a hallmark of government, and the current set of actors in Washington, DC is no exception. In these troubled times, one wishes that someone in political authority had even an inkling of what is needed to deal with the current situation in oil markets.

Instead, we have bluster, threats, and measure after measure that would further strangle and regulate production of oil and oil-related products. Congress always tells us that it knows best, but once again, we see nothing but economic ignorance from Washington's finest. For now, they have been held back by a filibuster, but I fear that such a reprieve is only temporary — that Congress and the others in political power in this country will not be satisfied until they have fully destroyed the US economy and replaced it with something we thought would disappear when the Iron Curtain finally fell so many years ago.