'Price Gouging' is not the Reason for Rising Energy Prices

To many critics of President Bush's energy plan, the cause of today's energy problems, particularly rising gasoline prices, is something called "price gouging." And what is that?

"We know that big oil has played a role in the price spikes and we know they are making business decisions to maximize their profits," said Rep. Jan Schakowsky (D-Ill.) recently.

"Powerful oil interests manipulated markets to limit supplies," said Sen. Paul Wellstone (D-Minn.). "I call that price gouging."

Whoa! First of all, maximizing profits is what every business tries to do. This is not some kind of evil, anti-social practice but, in fact, the mechanism that provides us with the necessities and the joys of life. As Adam Smith wrote in 1776, "It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self love."

How do businesses maximize their profits? Certainly, not by "limiting supplies," as Sen. Wellstone suggests. It's true that cutting supply in the face of constant or increasing demand raises prices, but cutting overall supply is rarely an option for a business. Monopolists and cartels (yes, including the oil cartel led by Saudi Arabia) occasionally get away with it, but not for very long.

The petroleum industry is viciously competitive - at the wholesale and at the retail level. Motorists, for example, flock to a gas station that cuts its prices a few cents below the station down the street. The Value Line Investment Survey lists 25 integrated oil companies, from Amerada Hess to Valero. Have they all colluded to cut supply and raise prices? Nonsense.

In fact, the history of the oil industry is a history of exploration and investment - the quest for more supply, not less. For example, according to Value Line, capital spending by ExxonMobil totaled more than $50 billion between 1995 and 2000. Chevron last year had a cash flow of $8 billion and plowed $5 billion of that back into capital investments to find and produce oil and natural gas.

The truth is that, as a result of this emphasis on supply (and on cost-cutting high technology), gasoline prices have been remarkably steady, adjusted for inflation, over the past 15 years despite big increases in demand. In 1979 and 1980, a gallon of super unleaded gas shot up to $1.50 but by 1986, it had fallen to 50 cents (in 1979 dollars). Since then, the price, adjusted for inflation, has bounced between 50 cents and 80 cents, with the biggest spike coming during the Gulf War, with the threat of severe supply constraints.

Yes, prices have risen, but do increases amount to "gouging"?

Wellstone and Schakowsky hitch their claims to a statement by the Federal Trade Commission chairman, Robert Pitofsky, that "there were some strategic choices by oil companies designed to maximize profits that contributed to the temporary price increases."

But what Wellstone and Schakowsky conveniently ignore is the rest of Pitofsky's statement: "Most of the causes were beyond the immediate control of the oil companies. ... Once the magnitude of the price increases became apparent, several oil companies moved aggressively to bring supply into the Midwest market, and the price spike was eliminated."

In short, profit maximizing helped solve the problem. A basic economic tenet in free markets is that, when prices rise, firms rush to boost production to take advantage of the situation. The increased supply that results then reduces prices.

As Orson Swindle, a Republican appointee to the commission, added: "The bottom line is that the problems in the Midwest were caused not by antitrust violations -- of which there is no evidence -- but by a combination of the EPA requirement and unforeseen market circumstances. Ultimately, the market worked to correct the situation. These conclusions, and not certain between-the-lines insinuations, should be the overarching message of the Final Report."

A three-year investigation into Western gasoline prices that the FTC completed earlier this month drew the same conclusion: Industry collusion - the only solid basis for claiming that price gouging had occurred - played no factor.

So what is the real source of gasoline price increases if it isn't price gouging? As Swindle indicated, look to government rules and regulations.

Sure, crude oil price increases by the OPEC cartel have had a temporary impact. But the Democrats' solution last year - to threaten some OPEC nations friendly to the United States with cuts in aid - only plays into the hands of OPEC nations not so friendly to us. A better way to pressure OPEC on prices is to remove impediments to affordable energy development here - to boost domestic supply.

Past Congresses and the Clinton administration have put large swaths of natural resources off limits. Whatever sense that may have made in the past, new oil and gas drilling techniques have substantially reduced the environmental damage drilling can cause. Congress needs to rethink the outdated restrictions, as Bush suggests.

Likewise, as much as it may appall Mr. Wellstone, the conflicting, confusing and damaging rules for reformulating gasoline need to be brought in line with common sense.

Today, more than 30 different reformulated fuels are required to serve various parts of the country. The Energy Information Administration, in reports on gasoline prices has repeatedly made clear that this balkanization of the gasoline market creates bottlenecks, supply disruptions and price spikes. The price run-up in the Midwest last year, the EIA reported, stemmed in great part from the Midwest's "unique reformulated gasoline," which was not typically produced by refineries elsewhere. When a Midwest refinery had a problem, it took several weeks for suppliers outside the region to change their formulas and meet demand.

And who began this splintering of the gasoline market? A Congress controlled by Democrats, with the consent of President George W. Bush's father. In 1990, as part of the Clean Air Act amendments that year, Congress mandated that 10 metropolitan areas with air quality problems begin using reformulated gasoline to clean their air. Part of the mandate was that the reformulated fuels contain 2 percent oxygen content by weight.

That was a good deal for corn producers. Corn is the source for one of the key oxygenates, ethanol. But the requirement hasn't been so good for the environment or for consumers socked with higher gasoline prices. MTBE, the most common oxygen additive, has seeped into groundwater where it becomes a toxic, long lasting pollutant.

Meanwhile, ethanol, according to a 1999 National Academy of Sciences report, actually may increase the level of ozone-polluting chemicals. The panel reported that the decline in smog in the 1990s was "largely because of better emissions control equipment and components of reformulated gasoline - other than oxygen additives - that improve air quality."

Finally, the oxygenates reduce gas mileage, increasing pollution and raising costs to drivers.

If Democrats were really serious about environmentally friendly energy production, they would go after the Bush program for not seeking the elimination of that scientifically suspect oxygenate rule. The plan instead calls only for the Environmental Protection Agency to study how to reduce the number of boutique gasoline grades around the nation.

But count on their silence. Key Democrats from corn-producing states, including Senate Minority Leader Tom Daschle of South Dakota and Wellstone himself, may hate oil company profits, but they have no qualms about using government mandates to gouge the public if it may help them maximize their vote count.

Made available through Tech Central Station (http://www.TechCentralStation.com. The views expressed within represent those of the author, and do not necessarily reflect those of Capitalism Magazine's publishers.

James K. Glassman is the host of TechCentralStation.com.