Got Gas? Antacid Doesn't Help at the Pump.

Gas prices have gone up for 35 straight days or something like that. On a completely unrelated topic, profits at four of the largest oil companies are expected to rise by 22-56% for the first quarter. Conservative commentators scoff at the idea that there is something amiss; it’s just that we are all too simple-minded to understand the market forces at work. I did pretty well in graduate business school, but I can’t find this higher economic principle they are talking about. It’s pretty straightforward to find a correlation between gas prices and oil company profits. Something just doesn’t jive when we are told that it’s nobody’s fault that oil prices are high; oil companies are just passing along their costs. I would like one of these apologists to define for me what a genuine case of price gouging looks like, if it even exists. Obviously, oil companies are passing along more than their costs or they wouldn’t have record profits!

Liberals want to penalize the oil companies for being profitable. “Tax Those Bastards!” is the rally cry of congressmen pretending to be champions of the people. While this might make us feel some sense of temporary satisfaction, it does nothing to motivate oil companies to lower gas prices. If anything, it encourages them to find more ways to spend money like giving all their execs a 7 figure bonus, fund quarterly boondoggles to resorts around the world under the guise of environmental studies, dump millions into dead-end alternative energy projects that are never expected to succeed, etc. Oil companies have fleets of tax lawyers and accountants who are masters at minimizing their tax liability. Besides, penalizing success is generally a bad idea.

So who is responsible for raping us at the gas pumps every few days? In a truly free market, an industry will attract new entrants until it reaches equilibrium (Michael Porter, Harvard Business School). In simpler terms, this means that competition will prevent price gouging of consumers. If the average profits in an industry are higher than others, enterprising business people will set up shop in that industry and be willing to accept a slightly lower price in exchange for market share. So maybe they only earn $20Billion rather than $33Billion in a quarter. Still not bad if you can get it. Nobody can claim (with a straight face) that the oil industry is not profitable, so it should be attracting new entrants that want a piece of that pie. But when is the last time we heard of a new oil company being formed? When was the last refinery built in the US? I’d like to see Wal-Mart announce that they are building 3 new refineries in the Midwest. They would proudly explain that, using the 21^st century technology, they can refine oil to produce a gallon of gasoline at least 12 cents cheaper than current refineries which were built in the 1970s. In addition, they will have strategically planned their location and distribution network to lower those costs as well. How long do you think Shell, Exxon and Chevron would price their gas 30 cents a gallon more than Wal-Mart? This is exactly the kind of price war the gas industry needs, but it never happens. Why?

The only explanation is that the oil industry isn’t really a free market. There are too many government imposed safety and environmental hurdles for a new entrant to overcome. This is a result of knee-jerk legislation by lawmakers who want consumers to feel like they are being protected. “There will never be another BP oil spill in the US!” “We will not destroy our Alaskan wilderness in the name of oil!” We might die in a fiery car crash too, but that doesn’t mean we should outlaw cars and freeways. These bumper sticker policies have so handcuffed the industry that it can no longer function as a free market, which is bad for consumers. Same case can be made for nuclear power. It’s easy to scare people into thinking you are protecting them. It takes more integrity to be intellectually honest about the risks and costs of feel-good legislation.