Free-market fuel price solution?

As the price of gasoline continues its long climb, there’s a collision of ideals that interests me.

On the one hand, our nation is unabashedly energy-dependent. Our government and society are wholly reliant on ready access to large quantities of low-cost oil. It is no exaggeration to say that the government could not long function in its current form in the face of $10/gallon gasoline.

On the other hand, we proclaim the supremacy of unfettered free-market capitalism. We instinctively recoil at calls for a windfall profits tax on oil companies. Oil companies are, under their inflated prices, enjoying the largest corporate profits in the history of the world. The market is bearing the cost and, if the cost goes so high that the market won’t bear it, the cost will come down again. Or so Adam Smith tells us.

My question is this: What do economic libertarians believe is the solution to the problem of fuel prices? Would they say there is no problem? Or that if there is a problem, inevitably the market will correct itself? What if the market will bear $10/gallon oil, but our government cannot afford to participate in that market and maintain current service levels? At what point must government step in, and what would it do?

27 thoughts on “Free-market fuel price solution?”

  1. At some point, if the prices are being artifically inflated, one company will realize the advantage to be gained by lowering prices slightly. Then the cards start to fall.

    Greed always takes over at some point, even if collusion is getting everyone fat and happy.

  2. “It is no exaggeration to say that the government could not long function in its current form in the face of $10/gallon gasoline.”

    Do you mean the government couldn’t afford to operate vehicles, or that there would be a revolution?

  3. Welcome back to the world of the living. I am glad you are on the mend…. even though we’ve never met.

  4. Picking up the gauntlet…

    Perhaps $10/gal prices would force the economy to seek alternative forms of energy consumption for vehicles?

    To date, we have the technology, but cheap fuel essentially prevents the need.

    The problem with government intervention here is that it ultimately stifles innovative ways to work out the problem. We only subsidize the same weaknesses that brought us to where we are today — nevermind whether it is government’s role to address the concern in the first place.

    I’ll leave aside the argument that companies are not allowed to make a profit, that we pay more for a gallon of milk or soda than we pay for a gallon of gas, etc.

  5. On my way back to Virginia the other day, I was talking to someone at a restaurant about gas prices. One of our contentions was that the price of gasoline doesn’t really matter to someone like George W, since he doesn’t have to pay for any of the fuel for his limo, helicopters, and Air Force 1. If people in federal positions had to pay for their own fuel, then they might have more of a problem with the prices.

  6. Well, Waldo, high prices will force us to ration the available energy supply or to seek alternative supplies of energy. The government can, if politicians so choose, shift the costs around, but — absent reducing taxes — it cannot alter the cost of fuel energy. It can legislate the money price of oil, but the costs will merely reveal themselves in other ways.

    So, if the real cost of oil is $10, and the US legislates $5 oil, how long do you think it will be until we have no oil available for purchase at any price? Not long.

    And it won’t be a case of the oil companies merely climbing down from their greedy perches and giving in to our demands. The global market sets the price of oil, not the oil companies. If the price of oil is $10/gallon, and the US government sets a price ceiling of $5, oil companies will happily sell their oil to whomever pays $10. (which, by law, will not be us)

    Incidentally, the oil company profits are high in dollar terms, but that’s because oil companies deal in a large market. Their profit margin is not exceptionally high at all. Even now, it’s 10%, which is well below many other industries.

  7. This country has never experienced full free market capitalism. Even during the late 19th century, when there was no Federal Reserve or regulatory powers, there were still high tariffs to protect native industry. As tariffs came down in the 20th century, regulatory powers and safeguards against economic collapse were on the rise. As we’ve begun removing the safeguards without raising tariffs, in fact reducing them to near zero, the economy is beginning to be buffeted by more and less predictable forces, both domestic and global.

    When democracy and capitalism clash, democracy usually wins. $10/gallon gasoline would not only force a change in energy policy, it would force a terrific shift in cultural practices. Vacations, commuting, teenage driving, NASCAR, rural life, the trucking industry … it would all change. Parents wouldn’t let teens get cars because of the cost. Merely having a car and driving it often could become a class or status symbol, rather than simply having a nicer car. When celebrities and politicians drive multi-vehicle SUV motorcades, will they become the equivalent of the 18th century aristocracy in their coaches?

    Now which is easier to imagine: American culture undergoing a painful shift that de-emphasizes the automobile, or Americans demanding that government do something to lower prices or rebate the cost?

    I’ve tried to convince people that this is not the fault of the oil companies, that fear and uncertainty about the Middle East and oil production/use is causing high prices (the commodities market, rising consumption in China, etc.). No one is buying that argument; everyone is blaming the oil companies.

    If economic libertarians carry the day in this argument, they’re also going to have to carry the American people kicking and screaming into this brave new world – maybe the “invisible hand” can help with the weight.

  8. I think it would force the oil companies to release those secret patents on the carburators that get cars 120 miles to the gallon, the patents they’ve squirreled away since 1974. That would be sweet validation for those of us who lived through the first oil crisis. As far as political implications, I think that George W. has already telephoned Gerald Ford for advice on how to best deal with the consequences, advice which I suspect consisted of “Bend over.” Frankly, those will be words for all of us to live by.

  9. Adam and Jon Henke makes some very good points. The public is not correctly perceiving the problem: and politicians (and hence the Government) tends to jump when the public gets upset about something that fundamentally alters their way of life. Or the politicians lose their jobs.

    That is the elephant in the room, that is going to trample all other issues.

    But at some point, at $10 or 6 a gallon, there isn’t much the Government can do (compounded of course by our deficits), other than seizing all domestic production of oil. Oil is, after all, 60% of the coast of a gallon of gas at the pump. And even then, we only get 1/3 of our oil from domestic sources.

    We also must remember that the publicly owned oil majors, are a tiny, tiny share of the global market.

    But, the majors are not blameless. you can only hide so much behind claims about their profit margins. After all these quarterly statements are not so much released, as they are managed. . .

    Their profit margin is a result of choices the majors made in the eighties. They consolidated, and adopted the economics of scale and volume over the fat margins they used to run under.

    They thinned out their reserves–to cut costs . Which has resulted in some of the violence in current price swings (their reserves used to act as price-swing-shock absorbers.)

    They also are making huge huge windfall profits on their upstream production. This has nothing to do with increased productivity on their part, just the fat turkeys the market is throwing into their laps. A commodity that costs them about, on average, between $20-$25 to produce, a commodity that they where selling last year for $50, they are now selling for $70!

    All this being said, we are headed for much higher costs. You can debate peak oil, but you definitely can not debate that Non-OPEC oil is peaking. There are numbers and then there are numbers.

    ExxonMobel’s production has been flat since ‘99. BP was forced in ‘02 to downgrade it’s production targets 3 times! Shell was forced to reclassify 20% of its “proven” reserves as “unproven”.

    And you know that these companies are spending a ton of money, and using all the fanciest expensive technology, trying to find the next huge field. But they just aren’t finding them!

    This is scary stuff, This isn’t the 80s when Saudi Arabia flooded the market to kill off the Russians (one of the reason for the USSR’s demise?). The Indians where not players in the 80s and China certainly was not a player in the 80s. Plus, we had the Iraqi oil. And right at this minute the Saudis are pumping at full tilt.

    There is absolutely no slack in the system.

  10. The free market can solve the problem, much in the same way that famine, war and disease can cure over population. While regulation has its problems, the only oil company to use the public resource for social justice is the state-owned Citgo company from Venezuela.

    This doesn’t mean that caps on windfall profits will do much to help matters though. The profit margin from the last quarter for Exxon-Mobile, for example, was about 9%. If you wiped out all the profit, this would amount to shaving about 25 cents off a $3 gallon of gas.

    Everyone feels the pain of rising fuel costs, but the free market is unlikely do anything to assist those who feel it most: the poor.

  11. We should definitely let the federal government solve this problem. State-owned oil; quotas on gas purchases; fixed prices.

    That would fix everything. And the federal government has a wonderful track record of taking over big problems and fixing them. Much more so than private enterprise.

  12. The big 5 oil companies posted an average 8.3% profit margin for the quarter. So please save your wrath for some other company that truly is profiteering, like Microsoft.

    People, this is nothing more than supply and demand. We are not opening enough new areas to allow supply to keep pace with demand (most current producing fields are “mature” and declining in production). Add to that the uncertainty of war, and the instability of many areas that produce oil, and you get high prices.

    And we had collective amnesia in the 80s and 90s, and assumed that high prices would never return. So we (including me) drive SUVs and drive more than we used to.

    It’s a very simple equation. We need more supply. And we need to reduce demand. There are a hundred ways to reduce demand. I confess I don’t know which one or ones is the best.

  13. And what would happen if we had a John Kennedyesque determination not to put a man on the moon but to rally all forces, governmental and tax incentive encouraged private forces to get us out of gasoline all together. Do you honestly believe we couldn’t do it? Are we short on the R&D to do it or on the will to do it?

  14. Sherry,

    I absolutely WANT to think we could do it. But it is not as simple as getting rid of gasoline, because we have natural gas constraints that are just as bad, and there’s no ethanol equivalent for natural gas. We have a FUEL problem. Assuming for a moment we could answer that issue, here are some impediments:

    (1) A President who has all the current political force of (name any dead President), and less intelligence.

    (2) A Congress with a leadership that has no vision. And I blame Ds and Rs alike for the lack of vision. Reid/Pelosi et al. is just as bad for the country as Frist/Boehner et al.

    (3) Fault on the part of the investment community for forcing companies to look to this quarter’s/this year’s earnings without regard for the long-term view. On the private side, it’s going to take a company with a Starbuck’s-like start-up vision, and a lot of capital, to force change.

    (4) Vocal, disruptive, ambulance-chasing interest groups on both ends of the spectrum. They live on controversy because that allows them to raise funds. Without controversy, they die.

    It is just my opinion, and a frustrated one at that, but in my view nothing is going to change unless we get a President like McCain or Warner, who either is not beholden to or willing to ignore to the current crop of losers in DC, and a broad, sweeping political mandate with that election that creates change in Congress akin to the Reagan landslide.

    What I think is likely to happen is that there will be a lot of election year demogogery, followed by some event that helps to lower prices in the short-term (probably price-induced demand destruction), and all of us collectively, with our sound-bite ADD, will forget about it until the next price crunch.

  15. If you want to ramp up your fear and, or despair, click on the link and read:

    Seriously, we in Central Virginia need to start figuring out what the next step is for us. I am now officially considering getting a motorcycle, which helps some, but in a deer-infested locale like ours, maybe not as much as I’d hope.

  16. Curious makes some good points. Though, I would first restate a sentence from my previous reply, these quarterly reports are more managed than they are released.

    So, I believe these profit margins are a little fatter than they are letting on. They have to be!

    Though their model is one of scale, they are selling a product that has almost doubled in value in the last year, alone.

    He mentions NG, which will be one of many great bridge fuels (in theory the reserves are plentiful, and burning it releases 30% less CO2 than oil, plus you can make synthetic gasoline out of it).

    But opening up more domestic drilling for oil, won’t help. The trend is what it is: Non-OPEC oil is peaking. And our own domestic reserves have most definitely peaked: In this country, all of our easy (that is cheap to produce) oil is used up.

    So, any supply we add to the system will be so miniscule and expensive to produce (that is it will only be viable to sell if the price of oil is sky high), that there would be no way that it would actually affect the price of oil.

    Take for instance the highest most optimistic estimates of production for ANWAR: about a million barrels a day.

    Well guess what, in this country we use between one and two million barrels of oil an hour!

    Speaking of Warner, did anyone get his message about his alternative energy plan? Looks like he is getting up front on these issues.

  17. If you are going to imagine a scenario at least imagine one that is reasonable. $10/gallon gasoline implies $200/barrel oil. Why isn’t that reasonable? Because at $70/barrel the oil sands and oil shale resources of North America (quite a bit bigger than Saudi Arabia’s reserves) are very profitable to develop. There will be a start up time to actually get that up to large scale production but if prices stay at this level it WILL happen. At considerably less than $200/barrel even coal gasification is profitable. And the coal reserves of North America are simply immense. Just the lignite reserves of North Dakota (low quality coal for anything else but perfect for gasification) provide energy reserves for several thousand years.

    What are we really facing right now? Oil prices, adjusted for inflation, are about the same as they were in the early 1980’s. But more importantly, the energy intensity of the economy (how much energy it takes to generate one dollar of GDP) is about half of what it was then, so the current high prices don’t affect us as much as they did then. Why are we so much more efficient? Because the free market worked and companies realized that they needed to reduce the effect of energy price hikes on their bottom line.

    By the way, I do recognize the global warming implications of all of this, but I’ll bet that gets handled by some sort of carbon tax that will push further increases in efficiency in terms of carbon releases. Having said that, I’m realizing that there is one way we might hit $10/gallon gas. It will happen if taxes on gas rise to $5-6/gallon. But I don’t see that happening anytime soon.

  18. Dorn,

    Your point about intensity and prices adjusted for inflation are well taken. But in the early 80s we where still coming off of those 70s (really high prices that killed our economy and created so much inflation) prices.

    And a lot of those gains in efficiency where mandated by the Federal government . . . can anyone say CAFE? (hardly pure freemarket) It wasn’t until the mid-eighties that prices plummeted, when OPEC flooded the market with oil.

    Also I was very wrong about the NG reserves; they are actually becoming get quite tight, because of the expanding use of NG’s in electricity production., About 30% of our power now.

    The same thing will happen with coal, if we start using coal for transportation AND electricity, and whatever else they would use the methane generated by gasification.

    What, they are saying 150 to 200 years of reserves for coal . . . but that is at current use. Cut that in half if we start using it for other stuff.

    Oil sands, So so very heavily subsidized by the Canadian Government (free market?) And they use NG to burn the stuff off. What are they going to use when NG is tight? (I have read that when they originally started thinking about it they wanted to use nuclear bombs). Also, dont forget the ridiculous pollution that is created by processing the stuff

    I would say $200 is a lot sooner than you think–without taxes.

  19. also,

    “so the current high prices don’t affect us as much as they did then”

    that is completely wrong.

    Yes, things are much more efficient, but we used that efficiency “dividend end”, not to conserve and give us a buffer to supply swings, but instead to consume more.

    Cars are more much efficient: so we started making and buying bigger, faster and more powerful cars.

    Houses ares much more efficient, build bigger houses, and have much more appliances and air conditioning, for the same expence we used to run a much smaller house.

    Look at the percentages of house air conditioned in the 70s or 80s vs today.

    This is a failure of the free market, because the free market makes decisions in the short term, not the long term.

    But, of course the market is going to correct all this mess, it just might knock us off our perch as the worlds only super power.

  20. There are a LOT more than 200-300 years worth of coal reserves in the US. Lets do the calculation:

    Allowing for inefficiencies in mining and conversion, 1 ton of coal is 2-5 barrels of oil. It depends on the specific assumptions. I’ll use one ton equals 2 barrels of oil.

    Saudi oil reserves =250 billion barrels

    US coal recoverable coal reserves = 250 trillion tons.

    So US coal reserves are equal in energy to 500 Saudi Arabias and the world certainly isn’t burning through anywhere near one Saudi Arabia per year.

    So just the US coal reserves could supply the world’s consumption of hydrocarbons for several thousand years. I’m a firm believer that technological progress will dramatically cut into our wasteful usage of hydrocarbons long before that.

  21. By the way I admit that I was remembering wrong when I said that just North Dakota had several thousand years of reserves. It turns out that is the number for the reserves of the US.

  22. Dorn,

    That is billion not trillion. Regardless, if you got your trillions and billions confused, The NMA? (The National Mining Association) If you where a buying a car, would you believe everything the used car sales man told you?

    These are quotes all from the Energy Information Administration. That is, as in dot gov.

    “The United States has the world’s largest known coal reserves, about 275 billion short tons. This is enough coal to last over two hundred years at today’s level of use.”

    Emphis on “at today’s level of use” re:

    “Coal production in the United States reached a record level in 2005, ending the year at 1,133.3 million short tons according to preliminary data from the Energy Information Administration (Table 1). Production in 2005 was 21.2 million short tons higher than the 2004 level of 1,112.1 million short tons, and surpassed the prior record set in 2001 by 5.6 million short tons.”

    “while total coal exports were up 4.1 percent in 2005, the average f.a.s. price per ton increased by 24.0 percent to $67.10 per short ton as the tightening world coal market continued to push export prices to unprecedented highs.”

    hmmm, how much is it going to increase this year, and the next year and the year after that?

    Also, to get all of this wonderful coal, the only viable economic method (you know, to be competitive in the global market) the only viable mining method is leveling mountains.

    I kind of think that is crazy. But that is just me.

    Coal gasification will certainly be part of the mix (because they can now gasify it and remove a substantial % of the C02. But it is only a short term fix, because, we use it faster (and we will be using it even more exponentially faster) than nature makes the stuff.

  23. You’re right, I misread the table by a factor of 1,000 and that mostly blows my argument out of the water. Instead of having hundreds or thousands of Saudi Arabias in the ground in the form of coal, we have only a few. That does surprise me. I was sure that the energy reserves in coal were at least hundreds of times the energy reserves in oil. So I believed the numbers when I made my mistake. Even so, the existence of those coal resources are going to set some upper limit on the price of oil for many years to come (just not 1,000’s of years as I originally said.)

    By the way, the reason I picked the nma website was because it gave the easiest table to read. There was no reason to accuse them of bias. They were giving the same numbers as the .gov site you mentioned.

  24. As much as I love reading Adam Smith, he never really included any particular quality of life as a factor in his equations. The whole idea of a totally free market is beautiful assuming that you don’t much care what your life or anyone else’s is really like. Somehow the fact that the consequences are ‘natural’ is supposed to make everything else ok. The free market becomes it’s own ends as well as the means. That kind of social darwinism has consequences for the lives of innocent people which are incompatible with the ‘moral values’ that have come to be espoused by modern conservatives. It’s quite a contradiction and the truth is that Republicans don’t really want a free market. They just want different regulations that favor their big donors’ interests.

  25. Dorn,

    yep you are right, sorry for the snippy tone. the eia site can be dense . . .

    We will just have to see if you are right about the downward effect on the cost of oil. I would just have to say the rise in demand that is predicted in the future is truly astronomical.

    For instance China added more coal power generation to their portfolio last year, than all of England’s entire electricity generation portfolio. And that is just coal! Not to mention all of those dams and ng plants they are building!

    My bet is that there is going to be a major supply shock some time in the near future that makes this all a lot more interesting . . . to say the least.

  26. I believe the present base cost of extraction of oil varies from about $4.00 a barrel (Iraq) to about $25 a barrel (US stripper wells).

    Dorn makes the (valid) point regarding the point at which sand and shale oil extraction becomes attractive (albeit I thought it was closer to $50 a barrel).

    Also, I believe that at around $70 a barrel, some high volume renewable (bio)fuels become economically viable without subsidy.

    Despite the present high oil prices, given the relatively low underlying cost of extraction/production at the moment, I believe it is highly unlikely that the big oil will take the threat of commercial sand or shale extraction at all seriously at this point. Similarly I would think there is little short term threat with renewables.

    I would suggest that it is possible we will see oil sitting above the $70 a barrel mark for a long time because, should someone actually go down the path of very large-scale alternative fuel production/extraction (in the region of multi-millions of barrels per day), big oil will be in a position to undercut, still make good money, send the competitor broke and pick them up for a bargain. (OK, that’s an ultra-simplicistic scenario. However, tangentially it may give an example of the short-sightedness of the market/big oil: by allowing the price of oil to spike so high and stay there it is likely that it has initiated serious research into the very thing that will likely be its replacement. Oh the irony.)

    So, in answer to the original question, for a variety of geopolitical reasons (as opposed to economic), I would suggest that, in the short term at least, it is far better to let the market dictate the price of this commodity.

    When the price ultimately comes crashing down, I would suggest that it would actually be in the national interest to push it back up again, or set a floor price, through regulatory controls/tarriffs (with staged removal) to ensure that alternative fuel sources remain commercially viable (eg shale, sand, coal-conversion, renewables). However it is extremely unlikely that the government would have the wherewithal to institute such a counter-intuitive measure.

    Indeed, were the government to go to market with a regulated floor price of, say, $45-$50 a barrel I would not be surprised to see the price of oil come down to that level and a serious increase in competing fuel products go in to large scale production.

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