- The Washington Times - Monday, June 26, 2000

You can't turn on a television set or pick up a newspaper without being confronted by some politician or activist loudmouth braying about gasoline prices. "Big Oil" is cheating us again, we're told, and by golly, someone has to get to the bottom of this. But before we all sign up for the lynch mob, perhaps it is time to take a deep breath and think this through.

If Big Oil can raise prices at will, what took them so long to figure this out? After all, gasoline prices are usually pretty low and rather stable, and the industry hasn't enjoyed unusually large profits over the past couple of decades. But legend has it that the industry is constantly looking for excuses to justify profiteering, and the June 1 mandate for reformulated gasoline in the Midwest is exactly the kind of excuse necessary to unleash Big Oil's predatory instincts.

The oil industry, however, doesn't need an excuse to raise prices. Under most circumstances, "profiteering" is not against the law. Companies are generally free to charge whatever they think the market will bear. If Big Oil is determined to jack up prices, it can do so any time it pleases.

Think about it: Price gouging can only occur if all producers jointly agree to raise prices in concert. Otherwise, the appetite for profit will subvert the entire operation. For instance, if a bunch of oil companies suddenly decide to sell gasoline at a 50 percent markup, some corporate official will realize that if he defects from the plan and sells at only a 25 percent markup, he'll make even more money than if he goes along with the gougers.

That's because he will expand his market share at the expense of his competitors while still making a hefty profit on each gallon sold. Free markets harness the lust for profit in exactly this manner, and low prices for goods and services are the inevitable result.

For a charge of "price gouging" to stick, then, someone's going to have to find evidence of collusion. But no such evidence has been put forward. In fact, despite three decades of on-again, off-again public witch-hunts and government investigations of Big Oil's alleged price fixing, no evidence has ever been found of a single instance of it. Price fixing is extremely rare for the simple reason that profit-maximizing firms have every incentive not to engage in it.

But what to make of the government's charge that no other explanation can possibly account for the recent surge in gasoline prices? First, let us tackle the economics. The demand for gasoline is inelastic in the short run. That is, it takes a big increase in price to get a little decrease in demand. Because prices are necessarily rationing devices, even a relatively minor disparity between supply and demand will have a big impact on prices.

That supplies are down in the Midwest is incontrovertible. Pipelines into the region have ruptured. A few important gasoline refineries are temporarily off-line. Refining capacity is at its limit. Moreover, demand is surging due to a growing, prosperous economy and the expectations of future price increases. More than half of the nation's gasoline storage capacity is in our gasoline tanks. Rapidly escalating prices encourage consumers to fill up today because filling up tomorrow might cost a few dollars more.

Inflationary expectations thus further fuel demand and make the supply/demand discrepancy (and thus, the necessary price increases) even greater.

The supply problem is largely due to inept government rules and regulations, which explains the desperate attempt by some politicians and policy advocates to scapegoat Big Oil. Reformulated gasoline not only costs more than normal gasoline, the mandate serves to balkanize the gasoline market, which makes supply disruptions more acute. The zeal to promote ethanol as a reformulated fuel makes reformulated gasoline even more expensive and enormously complicates fuel transportation. Refining capacity is limited because needlessly costly federal regulations and the constant threat of additional burdens on the industry have sapped refinery profits and, in turn, investment. Finally, new refineries and pipelines are nearly impossible to build thanks to NIMBY ("Not-In-My-Back-Yard") activism.

All that might be tolerable if reformulated gasoline served some useful purpose. But we now know that reformulated gasoline increases some emissions at the expense of others, making the whole crusade a bit pointless.

Unfortunately, there are too many political fingerprints from both parties on this fiasco to expect much straight talk out of the Washington. So expect the populist nonsense about Big Oil to continue for a while no matter how silly the argument.



Jerry Taylor is director of natural resources studies at the Cato Institute.

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