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Congress and Oil Prices: The Outrage Continues

May 6, 2002

One of the enduring myths about Washington, D.C., is that the political classes can be--or at least want to be--educated about economic matters. Individuals and foundations have sunk millions of dollars into "think tanks" and seminars, all in hopes of teaching basic concepts of economics to those who are in positions of political leadership. 

Lest we be tempted to fool ourselves into thinking that this is working, have a look at the latest outrage from Congress--a U.S. Senate "investigative report" on oil prices. The political classes and their media allies have cooked up yet another conspiracy theory on the evils of private enterprise. A conspiracy theory that claims Osama bin Laden was the mastermind of the John F. Kennedy assassination is more believable than this latest outrage of a congressional document.

According to the Washington Post, the report claims that oil companies are "manipulating the markets" through mergers and by "withholding" gasoline from the market in order to drive up gas prices. The sponsor of the report, Sen. Carl Levin (D-Michigan), claims that oil company mergers have left consumers vulnerable because the companies now "are able to raise prices without fear of competition. They are able to manipulate supply to keep it low, and as supplies are low, the prices will go up."

While Levin does show a little bit of knowledge on the role of supply in a market, he demonstrates once again that political instincts always trump economic reality. He goes on to cite a litany of statistics that, as we shall see, mean absolutely nothing.  

The Senate report says that, in 1981, some 189 oil companies owned 324 refineries. By 2001, only 65 companies owned 155 refineries, and this year, figures have declined to 63 and 150, respectively. The report further states, "Because of the decline in the number of domestic refineries, total domestic refining capacity is slightly lower than it was 20 years ago. At the same time, demand has increased. A tight market optimizes profits for a refiner.  

"In the summer of 2001," the report ominously continues, "major refiners affirmatively reduced gasoline production, even in the face of unusually high demand at the end of the summer driving season."

Levin further complains that gasoline prices in the U.S. vary widely from region to region. For example, gas prices in California are substantially higher than they are in rural Georgia and South Carolina. This, he says, is further evidence of conspiratorial behavior on behalf of oil firms.

This is a wonderful example of how to lie with statistics--something that politicians and their media allies have perfected over time. It is difficult to know where to begin in criticizing this outrageous document, but we must begin somewhere.

If one were to take this report at face value, one would have to conclude that (1) gasoline prices are substantially higher than they were 20 years ago, and (2) oil companies are much more profitable than they were in 1980. In fact, the opposite of these conclusions is true.

If one accounts for inflation, the average price of gasoline today (when gasoline prices have been recently rising) is more than a dollar less than it was in 1980, and that is not taking into account that substantial new gasoline taxes on the federal and state level have been placed on gasoline since then. If one were to take away the gasoline taxes, the price today would be roughly half of what it was two decades ago.[1]

In other words, the mergers and acquisitions that have taken place in the oil industry have not raised the price of gasoline, as the report claims. To say otherwise is simply untrue. Furthermore, in the last 20 years, average profitability of oil companies has been substantially less than other firms listed in the Standard and Poors Industrials Index.[2]  

In the world of mainstream economics, the ideal economic arrangement is an economy full of tiny, backyard companies which have tiny economies of scale, are numerous, and produce very little. That is what we call "perfect competition." The greater the number of firms that exist and the smaller their productive capacities, the better off all of us will be.

This, of course, is a picture of the precapitalist and pre-Industrial Revolution world. Three centuries ago, production was small-scale, and no one firm could dominate a market. While mainstream economists might celebrate such a state of affairs, we are also describing a world in which the average life expectancy was about 30 years of age, half of all children died within a year of birth, and the vast majority of people lived in unspeakable poverty. This is the world that the Carl Levins and a gaggle of economists say would be most ideal for all of us.

Besides the obvious debunking of the statistics that Levin and his tax-funded cohorts have thrown at us, let us further examine the charges he has laid upon the oil industry. For example, he says that oil companies are withholding present supplies of gasoline when prices are cheaper in order to sell gasoline later when prices are higher.

Such a statement presupposes that the markets determine prices, but since Levin has already claimed that oil companies are impervious to market conditions, or that they create market conditions on a whim, he has managed to contradict himself. Either oil companies control the markets or they do not.  If they do, then companies would not be engaging in speculative behavior, since speculation would be unnecessary. If they don't, then perhaps we need to look at the issue of speculation.

As elementary students of economics are supposed to be taught, speculation is an act of buying low in hopes that one can sell high. In the situation of oil markets, during slack periods of demand, companies may wish to withhold some gasoline in order to have more of it available when demand is higher. However, such behavior actually would tend to make prices more even over a long period of time--something that is the opposite of what Levin claims is really the case. (The report decries the large variability in gasoline prices, yet condemns oil companies when they try to do something about that volatility.)

According to Levin, withholding present supplies of gasoline is a crime against humanity, yet he supports the presence of the government’s Strategic Petroleum Reserve, which is a large stockpile of crude oil in the former salt domes of Louisiana. In other words, it is OK for the government to withhold crude oil from production, but wrong for oil companies to do so.

At the same time, the amount of present supplies oil companies can hold back is limited by capacity. By its nature, the oil industry is in constant flow. Oil comes from wells to tankers and pipelines, to refineries, through more pipelines, to storage tanks, and then to the final use as fuels or chemicals. Companies do not have much room to "hold back" anything, since to stop the activity in one place would invariably create bottlenecks elsewhere. This idea that oil companies have a Secret Hideaway where they are keeping their products from public sale is yet another version of the bin Laden-JFK conspiracy.

As for the regional differences in gasoline prices, the blame rests solely on federal and state governments. In the real world, when there are price differentials in different markets of the same product, supplies tend to flow to where prices are highest and away from where they are the lowest, something the ancients once called arbitrage.

Congress and state governments, unfortunately, have prohibited such arbitrage in the sale of gasoline. First, governments have blocked the construction of cross-country pipelines that would allow gasoline and other fuels to be shipped quickly to places where prices are highest. Second, the draconian rules of the Clean Air Act Amendments of 1990 require different formulations of gasoline for different regions, depending upon the permitted emissions levels.

For example, gas that is sold in rural Georgia is formulated differently than gasoline that is sold in Atlanta or California. (It should be noted that many of the required additives to help gasoline burn more "cleanly" during the warm summer months actually do little more than drive up prices. It is yet another failure of the command-and-control environmental regime that Congress and the Environmental Protection Agency have imposed upon us.)

Thus, when price differences emerge, especially during the warmer months, it is illegal to engage in arbitrage, since legal gasoline for South Carolina is illegal in other places. Furthermore, many states have used gasoline as a huge tax repository, which creates huge differences in prices between high-tax and low-tax states.

The kindest thing one can say about the Senate report is that the government has found no antitrust violations on behalf of oil companies. However, the whole thing is an exercise in economic illiteracy. One might wish that someday, all the efforts to give Washington some basic economic education could succeed, but I am not holding my breath. This is not for lack of effort on the parts of well-meaning people. Rather, it is because of the simple fact that Congress, the mainstream media, and their erstwhile allies can seize more power when they act out of willful ignorance than they can by being truthful and honest.

William Anderson, an adjunct scholar of the Mises Institute, teaches economics at Frostburg State University.  Send him MAIL.  See his Mises.org Articles Archive.

[1] William L. Anderson, "Uncle Sam’s Energy Mess: How the U.S. Government Empowers the OPEC Cartel and Takes Power from the People," Institute for Research on the Economics of Taxation, Studies in Social Cost, Regulation, and the Environment: No. 5, March 2001, p. 7.

[2] Ibid., p. 4.

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