Sticker Shock At The Pump

The other day I pulled into the Huck’s to fill up and paid $2.95/gallon or almost $50. Good grief!! This morning on CNBC, they are covering the debate over record oil prices. Are the oil companies price gouging or is it simply a supply and demand issue? Should the government impose a “windfall tax” to help consumers is another topic.

First off, if you break the problem down, it is a supply and demand issue. In recent years, developing economies such as India and China, both with a population of 1 billion people, are growing rapidly. Their demand for oil is also growing rapidly, which has put strain on our supplies. In a small way, we Americans also compound the problem with our desires for gas guzzling SUVs and love of travel, thus putting additional demands on the supply of oil and gasoline. And basic economic theory will tell you that high demand and low supply will translate to high prices. Supply and demand is what a free market is all about.

As for the oil companies, I don’t know if they are gouging per se, but it appears they are taking a monopolist's strategy to the problem. Oil supplies are being bottlenecked at the refineries. Oil companies, which are now flush with cash, have not built any new or additional refineries in a generation. So gasoline and other oil products are only produced at 1975-1980 capacity levels. And as a monopolist, what incentive do oil companies have to spend more capital to erect refineries so that prices can drop? A monopolist will charge prices to where marginal demand is equal to marginal supply. In layman’s terms, they’re going to charge what the market can and will bear. Granted oil companies are not a complete true monopoly, but they can work as a cartel.

And what should the government’s role in this be? Normally, I would prefer the government to stay clear and let free markets take its course. But there are things as anti-trust laws to prevent monopolies from taking advantage of consumers and ensuring reasonable prices for needed items. Do anti-trust laws apply here? I’m not an attorney, nor do I play one on TV, nor did I sleep at a Holiday Inn last night. I don’t know for sure.

However, there is talk of implanting a “windfall tax” on oil companies since they seem reluctant to do anything to ease this burden on consumers. I’m not sure this is the best idea. While I understand the idea that if the oil companies do not police themselves, the government will step in and that would be the deterrent for the oil companies to change. But questions on this new tax need to be asked. What is a “windfall?” For an umbrella salesman who sells an above average number of umbrellas on a rainy day; will that be a windfall and he/she will need to be taxed, though it was brought about from an unusual, one-time circumstance? What will be done with the windfall tax proceeds? Will gas taxes be dropped? Probably not. Regardless of the best of intentions, I do not favor the increase of any taxes.

It is time for the government to help foster the development and marketing for alternative fuels, such as bio-diesel, ethanol and hydrogen. Perhaps offer substantial tax breaks for the development of these technologies. Auto manufacturers are not going to spend millions of dollars to develop a car no one wants to buy. Even go as far as allowing any profits made from the sale of an all hydrogen-powered car will be tax free; offer tax credits for the purchase of such a vehicle. While this is a long term solution, it will help foster markets for alternative fueled-cars and lessen the demand for oil.

This is a shit sandwich that we all have to eat. And there’ll be more sandwiches to come.

Common Sense of it All: Paying nearly $3 for a gallon of gasoline, we now know how dependent we are on oil, whether foreign or domestic. We keep opening our wallet and paying the price. Instead, lets squelch our desires for SUVs, RVs and other gas guzzlers; let’s stay home a little more often instead of eating or going out; remember the “phone first” campaign during the energy crisis of the 70’s, time to bring that back; support alternative fuels and perhaps put public pressure on oil companies to expand refineries.

*Correction* - Ooops! Above I stated that a monopolist will set prices to where marginal demand is equal to marginal supply. This is what happens when you type too fast and don't closely proofread your work. More acurately, a monopolist will set prices where his marginal revenue is equal to his marginal cost. But the outcome is still the same; they will charge as much as the consumer is willing to pay.