Explore Harvard's Nieman network Nieman Fellowships Nieman Lab Nieman Reports Nieman Storyboard

Why gas is almost $4 a gallon and some ideas on what to do about it

COMMENTARY | May 01, 2008

Separating the real from wishful thinking on energy independence, short- and long-term oil price solutions, subsidies, speculation and government regulation.

By Martin Lobel, Henry M. Banta and Lee Ellen Helfrich

With diesel prices over $4 a gallon and gasoline prices approaching $4 a gallon, you would think that politicians would get serious about developing a rational energy policy. You would be wrong.

President Bush trots out his old “solutions.” If only we opened the Alaskan North Slope to exploration and gave the oil industry more incentives, our problems would be solved. Nonsense. If Congress authorized drilling on the North Slope tomorrow, it would be 10 years before that production would reach market. How would that impact prices today? And the notion that the oil industry needs over $15 billion in tax subsidies when oil is well over $100 a barrel and it is reaping record high profits again, only confirms that President Bush was serious when he said at a fund raising dinner where the cheapest seats were $1,000, “some call you fat cats, I call you my constituents.” The industry claims it only earns an average return when measured as a percent of sales, but measured as a return on capital, as investors do, you get a much different result.

Senators McCain and Clinton want to suspend the gasoline tax for this summer’s driving period, although Senator Clinton wants to offset the lost revenue with a windfall profits tax on the oil companies. Great pander appeal, but bad economics and not a chance of passage.

And, with a few notable exceptions, the media haven’t explained to the public what is real and what is wishful thinking. So let’s try.

Energy Independence is a fantasy. Forget it. It’s not going to happen. Politicians who claim they have a plan for energy independence either don’t understand or care about reality. The United States imports over 60 percent of its oil. There is no way we can develop enough energy sources to meet even our transportation needs without destroying large segments of our economy. Nor is there any way in the short term that we can significantly lower our needs for gasoline, diesel or jet fuel. In the longer term, we can certainly develop more efficient cars and trucks, but almost all economists agree the best incentive to do that is high gasoline and diesel prices which encourage people to buy more efficient means of transportation. Many economists suggest we do what the Europeans do, impose a high gasoline tax, and use the money for our neglected infrastructure, but that doesn’t seem politically feasible.

Energy subsidies: Do the oil companies really need tax subsidies with oil at well over $100 a barrel? The fact is, despite all their ads to the contrary, the oil companies have not really upped their exploration budgets significantly despite all those record profits. The companies can justifiably cite political problems in many of the best locations, including Nigeria, Mexico, Russia, Iraq and Iran, and the reluctance of other oil producing countries to allow increased production. But that doesn’t justify a need for subsidies or explain why the companies have been using so much of their profits to buy back their stock.

Dramatic short-term price increase: Increased demand in China, India and other developing countries does not explain why there has been such an abrupt run-up in the price of oil over the last two years. A significant part of the answer appears to be a speculative bubble, but we can’t be sure because a loophole in the reporting laws, put there at the behest of Enron, prevents us from knowing what is really happening in the market. That loophole needs to be closed by Congress immediately so that all significant trades are reported to the Commodities  Futures Trading Commission rather than hidden offshore. If transparency isn’t enough to curb the speculation, the CFTC should be required to report to Congress whether other steps, such as more regulations, are required.

Speculation could also be curbed by making it more risky. That could be done by merely announcing that the economic injury done to our economy by high oil prices is grounds for selling or trading oil in or committed to the Strategic Petroleum Reserve. At the very least, the government should sell the expensive sweet crude committed to the SPR in the free market when the market prices spike. The government could also time its oil purchases to moderate speculation. After all, it is one of the biggest purchasers of petroleum and products in the world. Surely, its purchases would have some impact on the market.

Inventory management could also dampen price spikes. To keep petroleum products flowing to the market, the system needs about a 20- to 21-day supply to keep the pipelines full and  refineries operating. Less than 10 years ago, the industry kept about a 30 day supply so that normal, expected interruptions in supply wouldn’t cause large spikes in the price of products. Now the industry has cut the supply in the system to about a 22- to 23-day supply so that whenever there is an interruption in supply, the prices spike and stay up for a relatively lengthy time. Europe mandates a certain amount of supply in storage to offset normal outages. There is no reason why we shouldn’t. The extra cost to the industry of maintaining adequate storage is far outweighed by the avoided cost to the consumers.

Government regulation: The oil industry blames government environmental regulation for the failure to build new refineries in the U.S. in the last 10 years. The fact is, existing refineries have been significantly expanded, but not by enough to meet demand. The Bush Administration told the industry that, if there were government regulations or red tape that was impeding the construction of new refineries, it would take care of the problem. Have there been any requests for new refineries? No. You would think that the industry would take advantage of the offer made by an administration headed by two oil men who “understand” the industry, but it hasn’t. Could that be part of the industry’s inventory management program?

Short-term solutions: As a practical matter, the best the government can do now to moderate price spikes is to force the industry to maintain adequate inventories and moderate speculation by making trades transparent and using the Strategic Petroleum Reserve and its own purchases to offset speculative price increases.

Long-term solutions: In the longer term, the government should help fund research to making solar, wind power and other alternative energies more cost effective. Then it should make that research available to anyone who wants to develop alternative sources of energy. It should not subsidize the production of alternative energy for more than a short time, otherwise all it will do is develop another welfare system. Look at ethanol subsidies: all they have done is drive up the price of food, lower the mileage of cars, and encourage uneconomic investments. Though ethanol has made a certain segment of the market rich, it has not helped the environment – the supposed justification for the program.

There is little the U.S. can do now to influence world oil prices directly. We are going to have to try to regain our credibility internationally and convince producing countries that it is in their interest to moderate oil prices. Whether that can be done will be up to the next president. The least we can demand from our presidential candidates is a credible plan to deal with both the long- and short-term problems created by high oil prices. High oil prices act as a tax on our economy, the only difference being that money goes to oil producing countries around the world rather than being recycled here in the United States.


The NiemanWatchdog.org website is no longer being updated. Watchdog stories have a new home in Nieman Reports.