The Mystery of Gas Prices
In spring of 2006 rapidly rising gas prices were on everyone’s mind. An article by Horsley (2006) examined the economic and political circumstances behind the rising gas prices. Gas prices are one of the most complex supply/demand relationships in the market. The factors discussed in the article still hold true today and continue to drive gas prices.
According to Horsley, the biggest factors in rising costs are the costs of crude oil and the cost of refining. The price of crude oil accounts or nearly 2/3 the final price of the final gasoline price. When gasoline was at $2.90 per gallon, the cost of crude accounted for $1.60 of the price. Crude rose 33% in 2005, due to political problems that affected the ability of oil producing countries to meet the supply.
Refining costs add approximately another 64 cents to the gasoline price. Refineries in the Gulf of Mexico stopped producing due to hurricanes. Refineries were also incapacitated due to the need to adjust their production to accommodate new requirements for low-sulfur fuel and the phase-out of the gasoline additive MTBE (Horsley, 2006). Taxes add another 55 cents to the price and distribution and marketing costs add another 11 cents per gallon. Big oil companies make most of their money by producing crude oil. There profits today are a result of speculation that took place when prices for crude were much lower (Horsley, 2006).
Oil prices are not set by the oil companies; they are set by the global market. Global demand has increased as countries like India and China become wealthier and more dependent on gasoline. When combined with already high U.S. usage, the demand continues to rise on a global basis. Production is controlled in OPEC countries so that the price can be artificially controlled through regulating supply in comparison to demand. Prices are maintained at artificially high levels, much higher than they would be in a competitive market. Prices are maintained as high as possible, but not so high as to encourage the development of alternatives (Horsley, 2006).
Government Interaction and Gasoline Prices
The U.S. government has interacted with the oil market, perhaps more than any other consumer product. One of the primary methods of intervention has been to encourage the development of alternative energy and more fuel-efficient vehicles (Horsley, 2006). In order to encourage development of these more fuel-efficient cars, the government issues tax breaks for the purchases or hybrid vehicles and fuel-efficient diesel cars (Horsley, 2006).
In addition to encouraging Americans to decrease dependence on foreign oil. The government has conducted investigations concerning alleged “price gouging.” They found that artificial price gouging on the part of gasoline retailers was not the case (Horsley, 2006). The government considered a windfall profits tax to make price gouging unattractive (Horsley, 2006). However, the oil companies fought on the basis that this would limit their ability to invest in new oil fields and refineries (Horsley, 2006).
Government measures regarding gasoline prices at the pump have targeted methods to manipulate supply and demand. They have also focused on making certain that prices are fair and that they are being driven by the capital markets instead of monopolies and oligopolies in the oil industry. Tax measures have focused on encouraging consumers to be more fuel-efficient and to reduce demand. Tax measures against gasoline producers are punitive and intended to prevent unethical practices by them.
The results of these efforts appear to have had an impact on the number of hybrid vehicles being sold and on the purchase of more fuel-efficient cars (Horsley, 2006). Yet, in 2005, demand for gasoline continued to rise (Horsley, 2006). However, the past of demand growth has slowed when compared to previous years (Horsley, 2006). It could not be expected that these measures would have an immediate impact on gasoline demand. Changes are likely to take some time before the real impact is felt. However, this slowing of demand growth is indicative that the process has begun and that it will continue to grow in the future.
The answer to resolving the issue of gasoline price in the future is the same for both short- and long-term goals. In order to control gasoline prices, supply and demand must be kept in a near-equilibrium state. However, OPEC will never allow this to happen, as this means that they are unable to maximize their profits by using their intricate knowledge of price elasticity and the market. The only reaction that the U.S. government has is to find alternatives to OPEC gasoline and to continue to find ways to decrease U.S. demand. Decreases in U.S. demand would have a major impact on world demand, as the U.S. is a key consumer of gasoline products.
If the government chooses not to intervene, but rather to let the capital markets fulfill their purpose, demand for gasoline products would continue to rise at an alarming rate. If new non-OPEC sources were not found, prices would continue to hover at just below the breaking point of the American consumer. A government effort is needed to jump start initiatives to decrease demand on foreign oils. Whether these efforts concentrate on developing more fuel-efficient cars or developing alternative fuels, the net result must be the reduction in demand for oil products.
Gasoline prices are a complex matter. They are a combination of factors that the government can control and those over which they have no control. The government can make an attempt to encourage Americans to reduce their dependence on foreign oils. They can take steps to make certain that gasoline retailers are not cheating the American customer. However, they cannot control the actions of OPEC and other foreign entities. They can join forces with other international entities, but in the end, it is OPEC who has control over their oil. Taking actions against OPEC can have a negative impact on the stability of relations with those countries that could affect other areas as well. Therefore, these actions can only be undertaken with extreme caution.
The government can take actions to encourage Americans to be more fuel efficient and less dependent on foreign oils, but in the end it is the American consumer that has the most control over the situation. They may be encouraged by government incentives offering tax incentives, but they will make their decisions based on the perceived benefit of their purchase decision in relation to all of the other factors that must be considered.
Government intervention in a capital market in a questionable subject for many economists. There is a concern that if the government intervenes too much, the integrity of the markets will be compromised. However, the government also has an obligation to protect the interests of the people of the United States. Therefore, in some cases, they must intervene to attempt to protect the markets for all. This is the case with gasoline prices.
High gasoline prices can have a devastating impact on other areas of the market. As consumers must channel more of their income into transportation, it leaves less to spend in other areas. This creates an imbalance where the gasoline market outpaces other areas of the economy. The government must take action to protect the whole economy.
Horsley, S. (2006). Q & a: What’s Behind High Gas Prices? NPR. Business. 27 April 2006. Retrieved 15 February 2009 at http://www.npr.org/templates/story/story.php?storyId=5365439
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