THE PRICE OF GAS

May 12, 2008 

During the late 1950s and early 1960s, gasoline was in such great supply that local gas stations fought for customers by seeing who could sustain the lowest price.  I recall during one “gas war” seeing the price drop to ten cents a gallon.  Those days are gone forever, of course.  A great many things have changed since then.  What hasn’t changed is the law of supply and demand.  The world’s available supply of oil is finite, much of it is located in politically unstable regions of the world, and the demand for it is soaring.  So does that mean we are destined to pay ever-increasing prices for a gallon of gas?  Not necessarily.

Petroleum, the principal ingredient in gasoline, is a commodity, and, like all commodities, it’s bought and sold on futures markets.  Yes, OPEC is a cartel that controls oil production output and therefore supply, but sellers and buyers also look at the other factors that affect the price of oil and set the price at what the market will bear. 

It’s always puzzled me why Congressmen and Senators don’t understand this, or at least pretend they don’t understand.  Every time the price of gasoline, linked to the price of oil but with its own supply and demand pressures (refinery capacity mostly), reaches new highs they hold hearings.  They call in the oil company executives to testify.  They decry “windfall profits" in front of the television cameras and threaten to tax them, but nothing changes.

Of course, not all politicians want to keep the price of gas down.  Many, citing environmental concerns, believe that we must cure ourselves of our addiction to oil.   Higher gas prices, including higher gas taxes, encourage conservation, and they believe they also accelerate research and development of alternative energy sources.  They agree we should be less dependent on Middle East oil, but they aren’t willing to vote for new drilling off-shore or in the Arctic National Wildlife Refuge (ANWR).  Many of these same politicians are US Congressmen who, incidentally, drive cars that are completely paid for, including the gas, by US taxpayers.

But with gasoline prices putting serious inflationary pressures on the US economy, and much of the world’s oil profits going to unfriendly governments, isn’t it about time we took a common sense approach to these problems?  Environmental concerns are important, but why is it so difficult to come up with practical, environmentally-safe solutions?  There are at least three good reasons why we don’t.

First, no matter how high the price of oil rises in the near term, I can almost guarantee you it will fall again in the not too distant future as supply exceeds demand.  Some estimates predict oil will be back down to under $90.00 a barrel by October.  That’s still high by historical standards, even adjusted for inflation, but it’s low enough to bring gas prices back to the low to mid-$3.00 range, a level Americans had adjusted to.

In the longer term, they could go even lower.  The world price of oil reached near $70.00 a barrel during the Iran-Iraq War in the early 80s and dropped down to below $20.00 a barrel in the early 90s.  Principal factors causing the current rise in oil prices--the Iraq War, Asian economic growth, and the weakness of the dollar--are not one-way streets.  China’s booming economy alone is responsible for a large portion of that demand.  The US economy regularly experiences downturns; China's economy will also.

When oil and gas prices fall, the pressure for action subsides, and in the partisan political atmosphere in Washington, DC, that’s all the incentive that’s required to postpone making decisions.  But as sure as gas prices come back down, they will go back up with the next crisis or the next surge in demand.  The long term trend certainly is up.

We’re still a good way away from the day when world oil supplies no longer can keep pace with world demand.  We’ll get there, but we’re not there yet.  Large untapped sources of oil remain in North and South America, Russia, and other locations.  

Second, politicians seeking votes in agricultural states and those who believe the most optimistic projections of ethanol advocates have supported ethanol as one of the answers to our energy problems.  That also allows them to argue that drilling in ANWR and new off-shore locations isn’t necessary.  But now we know that it takes a lot of energy to grow and transport corn to make ethanol.  And laws mandating its use and the incentive farmers have to grow corn to make ethanol are contributing to higher corn and therefore higher food prices.

Finally, many promising technologies like hybrid and hydrogen fuel-cell vehicles are developing nicely.  They’re still several years away from cost and efficiency levels that will enable them to rapidly begin to displace pure internal combustion engines, however.  Then it will still take fifteen to twenty years to replace the tens of millions of cars currently on the road.  In the meantime we still need large supplies of reasonably priced gasoline.

So with a presidential election a few months off, what do we want to hear from the nominees of the two parties about gas prices?  The gas tax holiday between Memorial Day and Labor Day proposed by John McCain and Hillary Clinton does nothing to address the real problem.  What’s their strategy for keeping gas prices reasonable while we wait for new technologies to power our motor vehicles? 

Seems to me there’s a common sense approach to the problem.  We must sustain levels of domestic oil production for the next twenty years that will reduce our dependence on foreign sources and keep the price of gasoline from adversely impacting the US economy.  This means temporarily easing restrictions on off-shore drilling and perhaps even ANWR.  We can do this without adverse unacceptable effects on the environment.

This will allow time to perfect technologies for vehicles that will greatly reduce the US demand for oil and replace those now on our highways.  Congress can help accelerate the process by increasing tax rebates for hybrid and hydrogen fuel-cell vehicles and provide other incentives for new technologies.  Finally, Washington needs to reexamine bio-fuel technology before we go too far down that road and discover we need to back up.

Americans don’t have to pay rapidly escalating prices for gas while we wait for new technologies to power our cars.  We have sufficient domestic oil reserves to significantly reduce our dependence on foreign oil and keep prices in check in the mean time.   Perhaps our next president will figure all this out and provide the leadership that's necessary to get it done.