What’s Causing Your Pain At The Pump

“You got ninety percent of the American public out there with little or no net worth.  I create nothing.  I own.  We make the rules, pal.  The news, war, peace, famine, upheaval, the price of a paper clip.  We pick that rabbit out of the hat while everybody else sits out there wondering how we did it.  Now you’re not naïve enough to think we’re living in a democracy, are you, Buddy?  It’s the free market.  And you’re a part of it.”

—Michael Douglas as Gordon Gekko in Wall Street

The price of a gallon of gas creeps ever-upwards, now pushing the $4/gallon mark.  Some might view that as a kind of tipping-point psychological barrier—I thought that about $3 gas—and some of you have suggested that it could be the best possible tool to defeat Obama.  But I see he’s now using it as his own campaign point, once again beating the dead horse of Evil Big Oil taking billions in subsidies that should be going to “green energy,” while unfairly gouging Joe Six-Pack at the pump.

Time for a little reality check. 

First, as the Wall Street Journal reported a couple of weeks ago, in current dollar terms the price of a gallon of gas in the U.S. has almost always been between $2 and $4.  Optically $3.79 looks bad because we’ve never really seen it, and most of us are old enough to remember when gas was a buck or less.  But the fact is that relative to your purchasing power today, that $3.79  isn’t really all that different than $0.93  was in 1986.

Furthermore, before we go laying the blame for your pain at the pump at the feet of Evil Big Oil, let’s consider just where the price of gasoline comes from in real life.

According to the American Petroleum Institute, 71% of the cost of a gallon of gasoline is the cost of the crude oil from which it is produced.  But before we flog Evil Big Oil for current crude prices north of $100/barrel, let’s remember that as large as they are, the major private oil corporations are relatively small players in the global oil market, which is actually dominated by the huge national oil companies in Venezuela and the Middle East.  I’ve discussed this before:  of the five companies making up “Big Oil,” only ExxonMobil at #17 even cracks the top 20 globally in terms of reserves.  COMBINED the five companies making up Big Oil would barely be the 10^th  largest oil company globally.  The simple fact is Big Oil has essentially no control over the cost of crude oil or gasoline.

But there are reasons oil is over $100, and gasoline is therefore as expensive as it is.

We need to understand the basic concept of a supply and demand curves.  When we decrease supply, we shift the supply curve to the left —the available quantity at any given price is less than it was previously.  This results in the supply curve intersecting the demand curve at a higher price point.  Likewise, if we increase demand, we shift the demand curve to the right--there is greater demand at any given price, meaning that the demand curve intersects the supply curve at a higher price point.  

As applied to our current gasoline situation, both decreased supply and increased demand are at work.  On the supply side, despite President Obama’s dubious protests that he’s been the most pro-drilling Chief Executive in history, regulation and government resistance to the permitting process are still limiting drilling (ANWR, anyone?).  The Obama administration’s blockage of the Keystone XL Pipeline project only adds to the problem by reducing the amount of crude available to U.S. refiners.  Abroad, turmoil in the Middle East continues to hamper production, further limiting supply.  On the demand side, the big driver is exploding growth in the developing world, particularly China and India.  Billions of new people wanting to drive cars equals a huge upswing in demand, with no added sources of supply to meet it.  And risk of war in the Middle East curtailing future supply has led to speculative investors being willing to pay higher prices now for oil or oil futures, betting that supply will drop further, resulting in even higher prices down the road.

The net result is we feel the squeeze from both sides of the supply/demand curve; the supply curve is moving to a more restricted quantity available, and the demand curve is moving dramatically to a higher quantity sought.  The equilibrium intersection is necessarily going to be at a higher price point, and neither move is something Evil Big Oil can do anything about. 

But government could.  It just won’t.

Government also impacts the price through taxes.  On average, 14% of the cost of a gallon of gas is taken up by government in the form of excise taxes.  That’s $0.56 on a $4 gallon.  It’s worse in states like California and New York, where the government take is over 19%.  You want to know who is gluttonously gouging you at the pump?  Take a look at the District, and your local statehouse.

Yet somehow Obama thinks that the solution to “high” gas prices (and the deficit) is to increase taxes on oil companies.  With taxes already comprising the single biggest component of the price after the cost of raw materials and refining, how is increasing taxes supposed to reduce that price?  And this idea that Evil Big Oil is receiving the benefit of some kind of unique and unfair form of federal subsidization is simply a lie.  As I've posted before, these “subsidies” actually consist of tax deductions and credits that are of a nature common to virtually all business taxes: deduction of intangible drilling costs such as drillsite preparation and engineering (similar to the R&D costs deducted by pharmaceutical firms), and tax credits for foreign taxes to prevent corporations with international operations from being double taxed (the same credit available to individuals).  

The fact is, between 2005 and 2009, U.S. oil producers paid over $98 billion in federal income taxes alone—that’s in addition to the billions in royalties paid on oil and gas production from government-owned lands—more than virtually any other industry.  The effective global tax rate on the oil and gas industry is 40%, which is higher than both the federal rate of 35%, and the average rate for manufacturers of 26.5%.  Eliminating the current tax deductions and credits (the so-called “subsidies” Obama is attacking) not only disadvantages the oil industry relative to other U.S. businesses, it disincentivizes production (thus further reducing domestic crude supplies), and harms the refining and retail side of the business.  The net result will inevitably be increased gasoline prices, not reduced—just check out Europe, where taxes comprise as much as 75% of the price of gasoline, and consumers pay upwards of two to three times what we pay in the U.S.

Nor is it necessary to increase taxes on oil companies to pay for “investments” in “green energy,” because those companies (actually more correctly referred to as “energy companies” for this very reason) are already doing that on their own.  Every major oil company in the world already has R&D departments investing billions of dollars a year to research alternative fuels technologies.  And if the future is, indeed, “green energy,” they have every incentive to do so.  But increasing taxes on them only leaves them with less capital to do that work.

Once again, this administration has it exactly backwards.  Increasing taxes on oil companies isn’t going to reduce the price of gasoline, reduce the deficit, help the economy, or accelerate a green future.  What it will do is give Obama a convenient Bogeyman to flail on the campaign trail before a gullible public. 

And they are the ones who will ultimately pay the price.