Energy policy makers tell you that they are working hard to bring you cheaper, cleaner, better gasoline. But the reality is otherwise. Nearly every trend in energy policy distorts markets, restricts supply, thwarts innovation, and shackles production. Let us discuss some of the fallacies that Washington continues to embrace, including some in the latest energy bills.
After Katrina knocked much of the gulf coast’s oil and refinery capacity offline, President Bush used the Strategic Petroleum Reserve (SPR) to release 30 million barrels of oil into a volatile market. More recently he stopped putting oild into the reserve.
In 1995, Congress expanded SPR’s capacity from 700 million to one billion barrels. Buying when supplies are cheap and abundant and loaning when supplies are expensive and scarce might seem like a good idea, but this strategy in the response to hurricane Katrina and then rising gas prices has not been very effective. Prices are still high, SPR releases discourage producers, and no one really believes government can operate effective hedging program or that it would be an effective solution for our energy problems.
The high price of energy has many sources, but legislation is a main one. The legislation has come in the form of regulations and finance policy. Regulations through the EPA have distorted the incentives so badly that oil refineries now have more incentive to invest in sulfur-reducing environmental techniques than investing in the increase of capacity.[1]
Contributing to the distorted incentives is the pork-lined Energy Bill. Consumers receive up to $3400 of tax credit on hybrid vehicles, and businesses will receive loan guarantees for technologies such as clean coal, nuclear power, wind, and other types of renewable energy.[2] But the $11.4 billion in tax breaks and incentives over the next ten years for those industries will not lead to cheaper energy.
The subsidization of these industries has yielded very little as American people are still driving powered gas vehicles and getting much of their energy from “dirty” coal and other fossil fuels.
If an energy source beyond the likes of petroleum and coal were as effective in providing cheap and efficient energy, it would not need subsidizing. Companies will seek the cheapest and most efficient method to produce energy without government involvement. If the technology is as promising as it sounds, they will not need government incentives to pursue it.
Of course, tax breaks are great and better than outright mandates. However, targeted tax incentives for supporting technologies can distort rational economic decision making concerning what to produce. Congress supplants those ideas by influencing how capitalists invest in technology. No one entity can determine the direction energy will take in the future. Since Congress does not bear the ultimate cost of a wrong decision, the idea that they can somehow guess correctly is implausible. The favored industries have yet to flourish on their own merits. They will not likely increase the supply of energy or protect the environment, yet this is the most pressing and cryptic problem we face.
The Clean Air Act requires that 2% oxygen be added to gasoline. Methyl tertiary butyl ether (MTBE) and ethanol are the two most popular choices to fulfill the requirement. The new Energy Bill requires 7.5 billion gallons of ethanol a year to be used as a gasoline additive by 2012, a near doubling of the current use. Ethanol is heavily subsidized — and has to be in order to be available. It actually requires 70% more energy to produce ethanol than it provides. If ethanol were efficient under normal market conditions one would witness ethanol being used voluntary rather than thrust on the industry by mandate.
MTBE is the most efficient way of adding oxygen content to fuel and MTBE burns cleaner than ethanol, which is known to cause smog. However, recent discoveries of leakages into groundwater have caused a legal and political stir and it could be phased out. If it is phased out, with no oxygen mandate, the cost to the industry will be about $1.4 billion.[3]
No new major refinery has been built in the United States since 1976 and the 149 existing refineries are running at near full capacity in concentrated areas. The refinery infrastructure is not as strong as it could be without regulations. The New Source Review (NSR), administered by the EPA, determines what construction is allowed. NSR is one of the main contributors to the lack of versatility, which is usually one of the market’s greatest strengths. Regulations have made it virtually impossible to build a new refinery.
Companies like Arizona Clean Fuels have been trying to build a refinery for almost a decade. It took them 5 years to get the air-quality permits, and the refinery is suppose to be operational by 2010 — 15 years after they began the process.[4] The EPA also determines what emission limits must be met and often how the emissions source must be operated.[5] This results in billions of dollars in compliance costs.
Therefore, it should not be surprising that despite the restrictive entry (which is often cherished by favored industry) the returns on the oil refineries are 5.5% compared to a 12.7% return on stocks. This undoubtedly causes a bottle-neck within the delivery system of gas products. It does not matter if the United States gets all the crude in the world for free; it must be refined. None of these issues are addressed in the Energy Bill.
The bill that will reach the senate sometimes this year, Gasoline for America’s Security Act (GAS), originally attempted to loosen the NSR rules. But in order to get it through the House, that clause was withdrawn. The senate’s version does not address NSR rules at all. These two bills also provide many “streamlining” provisions. Legal challenges to refinery permits will be moved from state and local courts to federal courts. The Department of Energy (DOE) will take the role of locating refineries instead of the individual states and the GAS Act allows authorization to build refineries on federal lands, specifically closed military bases. This might provide some relief in the short term but federal authority could become even more restrictive, depending on how the political wind shifts.
Both versions of the GAS Act reduce the amount of boutique fuels supplied, from about 18 to 6 which will be phased in. Each state now has different standards, and supplying a more uniform set of fuels would result in a delivery system that could be more responsive to localized incidents. The GAS Act will also cut some red tape in establishing regional pipelines for petroleum. The “streamlining” that could take effect might improve gas prices, but the energy market has not been set free. Everything is still run through government (albeit at a different level) and it does not allow free markets to work.
The proposed GAS Act, also outlaws price gouging, and under this bill, companies that sell crude oil, gasoline, diesel, or home heating oil at a “gouging” price will be penalized by the Federal Trade Commission and subject to civil penalties. If the prices of oil and its derivatives are unable to float according to market demands, there will be shortages or rationing. If prices in a disaster area where supplies are short are artificially held low, producers will not receive the economic signals to try to get goods to that area. If gouging becomes illegal, consumers will respond to a lower price by consuming the same amount, or even worse, hoarding for fear of less access to the good in the future, leaving others without. Gouging encourages producers to go to great lengths to supply goods and resources and for consumers to conserve.
New regulations are continually being phased in by the EPA. In the year 2006 alone, expect a few cents added to a gallon of gas due to regulations. In the third quarter of 2006, the ultra-low-sulfur diesel market will have to meet a new 15-parts-per-million standard rather than the previous 500-parts-per-million. The Energy Information Agency estimates the extra cost of producing this fuel will range from 4 to 6 cents per gallon. The final stage of tier-2, low-sulfur gasoline started on January 1 of this year, mandating a standard of 30 parts per million, far more stringent than the previous 300 parts per million. This will cost from 1 to 2 cents per gallon.[6] The marginal cost of making the air cleaner is becoming more and more expensive.
Not nearly enough of the serious issues concerning energy have been solved or even addressed in either the enacted or proposed bills in Congress. Government continues to send distorted signals. The wrong incentives remain, operation of refineries are still expensive, environmental regulations are still being implemented, and government remains very involved in the entire process. There was a small response in Washington after prices reached $3 and $4 per gallon. At that rate, it will likely take $8 per gallon of gas to get the political will to overturn the monopoly the environmental groups have on oil policy.
Jonathan Puryear is an economics student at Wofford College who is doing research at the Mises Institute. Send him mail. Comment on the blog.
[1] ICF Consulting, “Long Term Crude Oil Supply and Prices”, January 2006 (PDF)
[2] H.R. 1640, Energy Policy Act of 2005, as ordered reported by the House Committee on Energy and Commerce on April 13, 2005.
[3] Petroleum Institute, “Operating at Record Levels,” January 2006
[4] Reason Foundation, “Katrina Reveals Gas Price Folly,” January 2006
[5] EPA, “New Source Review,” January 2006
[6] Energy Information Administration, “Short-Term Energy Outlook”, January 2006
