Mises Daily Articles
The Path to Lower Gas Prices: Free Trade
There are many reason the price of gas is higher than it otherwise would be in a pure market setting. But one reason has received virtually no attention. Gas imports are taxed more highly than oil imports, a protectionist arrangement that benefits domestic refineries (in the short run) but harms consumers every day.
First some background.
The increase in the price of gasoline has been a concern to all who take interest in the American economy. While prices today are not nearly as high, in real terms, as those of the early eighties, the recent doubling in energy costs certainly places a damper on the economy.
Congress is threatening the oil industry with a "windfall profit tax" for their "excessive profiteering," and wall street, by all appearances, is circling the wagons and preparing for the worst, even while non-energy company profits continue to grow at respectable rates. Meanwhile, the government has managed to erect barriers to entry for refineries and heavily tax the very lifeblood of machinery, oil.
The effects of taxes and regulation on the price of gasoline have been well documented. In South Carolina, consumers are made aware of the 35.2 cents tax per gallon by stickers conveniently placed on the pump. This is a two part tax with 18.4 cents going to the Federal government and 16.8 cents going to South Carolina, and the latter portion varies from a little under 10 cents to about 40 cents depending on the state.
This tax has the effect of increasing the price of gasoline, especially when the demand for a product, such as gas, is inelastic1 even in the long run, reducing the volume sold in the country, trimming profits, and suffocating incentives to develop new wells and invest in refineries.2
Regulation is nothing more than a tax where the government chooses to take it's revenue in the form of goods, such as pollution reduction, paperwork in triplicate, and graft, rather than in tax dollars, but the effect is the same as bilking the industry out of it's profits through taxes.
The combination of high taxes and complicated regulations have prevented the construction of refineries in the United States since 1976. Aramco, an oil company owned by Saudi Arabia, has even offered to build two new refineries in the United States; but only if "someone else obtains all the necessary environmental permits first."3 It is not surprising that America's refining capacity hasn't increased since the early eighties.
Unfortunately the above-mentioned problems are not the only source of gasoline's high price. A lesser known tariff is affecting our gas market everyday, and effectively boosts the profits enjoyed by our domestic refineries. As any good Austrian economist knows, tariffs are a protectionist measure, that, in the long run, will prove detrimental to the very industry meant to be protected. Under tariffs, and protectionism in general, inefficient firms are supported and competition is inhibited; this reduces the incentive for a firm to remain competitive and productive and will eventually result in a correction when regulations are lifted, or foreign firms become much more efficient than their domestic counterparts.
Keynes may have concluded that "in the long run we are all dead," and his thoughts certainly find sympathy with Groucho Marx who asks "Why should I care about posterity? What's posterity ever done for me?," but America has proven to be an ongoing concern and the long run should be considered. Protectionism is an outdated part of the antiquated mercantilist theory, and America should not be persuaded to wall off oil refineries from foreign competitors in one of our most important and vital commodities.
A 42 gallon barrel of crude can be turned into 44.77 gallons of merchantable products. Further investigation shows a barrel of crude oil yields, on average, 19.65 gallons of gas and 4.07 gallons of jet fuel, combined; this is well over half a barrel of the best product, and there is still a whole host of other derivatives manufactured from the same barrel.4 Refining oil, and then transporting the finished good, is no more cost effective than transporting oil, and then refining. This is apparent in practice since refineries tend to be near their markets, and most long distance shipping is for oil. The transportation of oil is actually more efficient since a pipeline can be built to pump a conglomerate of goods, rather than having to ship individual products in separate containers.
The tariff on gasoline and jet fuel imported into America is 52.5 cents a barrel compared to only 5.25 cents a barrel for unrefined crude: To simplify, the tariff on these finished goods is ten times the tariff on the unrefined oil.6 This translates into 1.25 cents per gallon of gasoline added to the cost of importing. This seemingly minor margin can give domestic producers an edge in the American market.
According to ConocoPhillips, refining and marketing profits for the third quarter of 2005 were 9 cents per gallon with an average price of $2.60 per a gallon of gasoline.6 Without trade limited by a tariff on gasoline, profits would be squeezed, roughly, to 8 cents a gallon.7 Thus the tariff increases refineries' profits by 12.5%, or 1 cent on the gallon.
As any entrepreneur knows, a 12.5% increase in profits is remarkable. Protectionism such as this allows inefficient refineries to continue to operate within the United States, while competitors are prevented from importing gas at market prices. From the consumers' perspective, the extra one cent on the gallon translates into 42 cents on the barrel, and at 20 million barrels per day the American consumer spends an extra $8.4 million each day to support domestic refineries.
Further complicating the importation of refined gas is America's obstinate application of environmental restrictions to foreign countries. Venezuela has filed complaints with the World trade Organization several times over Congress's and the EPA's requirements for cleaner refining. America, Venezuela charges, studied her own refineries, decided a 15% decrease in emissions was necessary, and then required Venezuela to do the same, without examining the emissions of Venezuelan refineries.8 This global application of EPA requirements is Congress's peace offering to domestic refineries after requiring them to meet stringent clean air requirements, and the tab of course is being picked up by every consumer of gasoline in America.
Eliminating the tariff on gasoline would not make a noticeable difference in prices at the pump, but would, more than some misapplied "windfall" tax, send a clear message to the oil industry that inefficiency among our domestic refineries will not be tolerated. To measurably reduce the price of gasoline the government should eliminate the excise tax placed on each gallon and reduce the regulations the industry must comply with. If America proves unwilling to reduce regulation on refineries, then the oil industry will simply move their operations off shore and import the finished good, and this natural progress should not be impeded by a mercantilist application of protectionism for the benefit of our overly burdened, inefficient domestic refineries.
- 1. The exact measurement, according to Molly Espey is -.42. Espey, Molly, "Explaining the Variation in Elasticity Estimates of Gasoline Demand in the United States: A Meta-analysis," The Energy Journal, 17, 1996.
- 2. For a more thorough covering of the effects of a tax read William Anderson's article "Fallacies of the Oil Tax." November, 2006.
- 3. Featherstone, Charles, "The Myth of 'Peak Oil,'" January, 2006.
- 4. Energy Information Sheets, "Crude Oil Production," January, 2006.
- 6. a. b. Energy Information Sheets, "Taxes," January, 2006.
- 7. This number is calculated using the inelasticity of demand for Oil.
- 8. American.edu, "US-Venezuela Gas,", January, 2006.