Soaring gas prices? Don’t blame the oil companies
By Beth Cody, Writers’ Group member
Iowa City Press-Citizen
Wednesday, May 10, 2006

How incensed were you after your last trip to the gas pump? High gas prices are discussed in the news almost daily. But why exactly are gas prices so high? Are the big oil companies “gouging” us? Is there anything the government can do to help consumers? The issues are complex and answers are hard to find.

The price of gasoline, like the price of anything in a free market, is determined by supply and demand. This is just common sense. However, common sense is often forgotten when hot-button political issues arise. Many people blame the “big oil companies” and their “outrageous profits,” and politicians make threats of “windfall taxes” and investigations of price gouging.

It is true that the oil companies have profited from recent high gas prices, although Exxon’s profit margin, at 10.7%, compares poorly to Yahoo’s 45.5% or Citigroup’s 33.4%. And returns in the oil industry over the last twenty years have been less than average, according to the Cato Institute, a libertarian think tank. Gas companies make only about 8 cents per gallon of gas after expenses. Compare that to the nearly 40 cents per gallon in taxes you pay to the Federal and Iowa governments.

And when we grumble about “big oil” getting rich off our backs, who exactly do we mean? A company is really just the shareholders, made up in large part by mutual funds. Since over half of U.S. households have pensions or 401k plans invested in mutual funds, the real owners of the oil companies are your neighbors. The duty of any company is to try to make money for its investors, the ordinary people who plan to retire on the pensions and 401ks they’ve earned over the years. It’s easy to find scapegoats for problems, but “big oil” isn’t to blame here.

The oil companies don’t cause high prices. They are caused by higher demand for gasoline, and not enough supply to meet that demand.

Higher demand comes from the world market for oil – U.S. demand for oil keeps growing and countries like China want to be just like us. President Bush can urge us to conserve energy until he is blue in the face with little result – when we want to drive someplace or turn up the heat, that’s what we’ll do and there is nothing wrong with that. The only thing that will increase our desire to conserve is higher prices – and because we are so wealthy, prices will have to increase much more than they have already for us to make any meaningful changes in the way we live. We complain about prices, but we continue to buy gas. So demand continues to grow and this drives up the price.

However, U.S. and other countries’ demand didn’t just rise this year; it has been slowly growing for decades. So why did prices rise so quickly?

Because of the supply side of the equation. Commodity speculators, who are the real price-setters, believe that oil supply may face disruptions due to the war in the Middle East and political turmoil in Nigeria and Iran. The speculators set the price through their bets in the commodities spot markets that oil prices will rise or fall. The oil companies have contracts with the gas stations to sell them gas at prices based on those commodity market prices. So is it the evil speculators’ fault that prices are high? No, it is really the underlying world situation that is causing prices to rise, as it should.

So what about the charges that consumers are being “gouged?” Price gouging is defined by some as charging “excessive” prices, especially during an emergency. But as long as more than one company exists, they will compete to sell at cheaper prices than each other. Who’s going to pull into the gas station charging $2.80, when the station across the street is charging $2.75?

In a free country, companies are free to charge whatever they want for their products. Customers don’t have to buy so much gas. They could carpool, ride their bikes, take the bus, trade their SUV for a hybrid car or move closer to where they work. And where’s the emergency? Talk of “gouging” is merely political fearmongering.

So what, if anything, can the government do to help us? Well, the WORST thing would be for the government to try to dictate the price of gasoline. Price caps led to very long lines at gas stations in the 1970s, because sane business people don’t sell at a loss.

An idea almost as BAD is threatening to impose special “windfall” taxes on oil producers. The goal should be to encourage more supply, to lower prices. Who would invest money in an industry with even higher taxes (lower profits) than other industries? U.S. supply would decrease, not increase. (The taxes would only be on U.S. companies, so foreign oil would be cheaper and we would buy more of it -- is that what we really want?)

Also, it is not the government’s business to meddle in the development of alternative fuels. The federal government’s heavy-handed attempts to encourage the use of ethanol instead of MTBE (an additive) are great news for Iowa agri-business, but will cause fuel prices to rise even more, especially on the coasts, and will cost taxpayers billions in subsidies (a hidden gas cost). Alternative fuels will sell themselves when they become cheaper and better than good old gasoline.

Something GOOD the government could do would be to lower gasoline taxes. Consumers would pay less and companies would profit more at the same time, thereby encouraging more production and even lower prices. Big government needs to get out of the way and let the libertarian free market determine the price we pay at the pump.