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The Angry Economist

What Should We Do About $3+ A Gallon?
Posted by William P. McGowan, Ph. D. on May 7, 2006 - 7:10:00 PM


UNITED STATES— While the general news media wails about the high cost of gas and the effect it is having on the common man, the financial press sits back and seems to be unfazed by the impacts this price spike will inevitably have on our economy. Maintaining a kind of "we told you so" stance, editors of the world's financial dailies all agree that one of the main reasons we are in this mess is that politicians and the general public either don't understand the basic economics of oil and gas, or they are willfully choosing to ignore them.

Remember that we haven't built a new refinery in the United States since the 1970s, while our population continues to grow.  In California alone, we've added almost ten million people to our state's population.


Simple Economic Fact #1: there is more domestic demand than there was thirty years ago.      


Most of the debate about American energy prices is also taking place as if in a vacuum, when the reality is that China and India are rapidly gaining in terms of petroleum consumption. Experts estimate that by 2015, China will consume more than the United States. 


Simple Economic Fact #2:  there is a whole lot more international demand for oil.


A vast majority of the current supply lies in politically unstable parts of the world. Beyond the Middle East, which mainly supplies Europe, consider events in Venezuela. The nation supplies a substantial portion of American oil imports, is headed by a man who idolizes that icon of human rights, Fidel Castro, and is in the process of nationalizing private oil company properties he hasn't already taken.  Through a political purge of the state-owned petroleum company over the last five years, production in Venezuela is down.  


Simple Economic Fact #3: Supply is tight and unstable.


Finally, too many Americans are putting too much faith in that "wonder fuel," ethanol.  While it is wonderful that we can grow energy in cornfields, the problem is that as presently drafted, our fuel alternative market is confined to domestically produced ethanol, which benefits one company, agribusiness giant Archer-Daniels-Midland (ADM). What amazes me in this run-up of gas prices is that everyone is alleging price fixing by the OIL companies, who have been investigated and cleared by the FTC numerous times. At the same time, the public and the press are idolizing ethanol as a viable alternative, even though a) it is more expensive than gas (even at today's prices) and b) is primarily produced by a company that has been investigated AND CONVICTED of price fixing before. 


Simple Economic Fact #4: Domestic supplies of ethanol are being kept artificially low by political barriers.


As an economist who believes in the power of capitalism to achieve good things, I have faith that the market will respond to facts #1, #2, and #3. Indeed, the gas prices may even bring enough attention to ethanol to get people asking why we don't import the stuff if it's cheaper than subsidizing the Iowa presidential primary. Many good alternative energy ideas died a quiet death in the 1980s and 1990s because the price of gas was so cheap that inventors could not get investors to see a profit in a reasonable time frame.  High gas prices will change that over time.  They will breathe life (and more importantly) capital into alternative ideas that will, eventually, beat down the cost of fuel.


At least, if we let the market work, they will.





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