Gas Insanity – 2011

Einstein famously defined Insanity as doing the same thing over and over and expecting a different result. Based on this definition, we are once again entering into insanity when it comes to gas prices. I have been observing this since the 1980s, and I am sure that it goes back before this. Every summer prices go up and people start grumbling about “Big Oil.” If they go up a lot, the politicians get involved, demanding investigations of the oil companies. The summer turns to fall, demand lessens and prices decline, people’s interest turns to other things. Then the results of the investigation come out and the oil companies are cleared. The net result is that nothing happens. Then the next summer comes and the whole thing repeats again, except that most years the problem slowly gets worse. Insanity.

In reality there are several problems here. The first is refineries. In 1982, there were 301 operable refineries in the United States. Currently the number of refineries is only 148, less than half the number. While from 1983 to 2009 average US Total Gasoline Sales by Prime Supplies went from 287 million to 363 million gallons per day.  (It peaked in 2007 378 million but has declined with the economy.) Not too surprisingly this has been accompanied by an increase in utilization rates for the refineries which are now near 90%.  In fact we can no longer refine all the gas we need but must import 250,000 barrels of gasoline a day.

This is why the prices jump whenever there is problem at a refinery. There is simply no slack in the system. So given that while we increased our consumption by 26%, we cut the number of refineries by over 50%, doesn’t it make more sense to at least consider building some new refineries as perhaps a better solution to higher gas prices?

The other major factor is the role of Government. Not only has its policies and regulations contributed to the drop in refineries, its taxes also have a major effect not only at the federal level, but at the state level as well. In fact, government makes far more on a gallon of gas than the oil companies.  The effect of states and county government can be seen in a nice map from GasBuddy.com. While some of the differences can be accounted for by transportation costs, looking over the differences in prices it is pretty clear that government is the major difference between having to pay $3.35 or $4.26 per gallon.

Government’s restrictions on oil production also artificially drive up the price by reducing supply.   Thus for example, recently Shell Oil had to postpone drilling when permits which had been issued were rescinded by the EPA.   As U.S Rep Don Young put it, “Shell has spent more than $3 billion and been ready to put Alaskans to work for the last few years but because of an inefficient bureaucracy and an overabundance of unnecessary regulations, they still have not been able to drill a single hole.”

When a federal judge ordered the administration to end its moratorium on drilling in the gulf, the administration responded with what critics call a permitorium,  there is no moratorium, there is just no permits being issued, and the net effect is the same.

These and other efforts to block production are defended with claims that they “wouldn’t do anything to bring down the high gas prices because the wells wouldn’t start producing significant amounts of oil for several years, assuming the exploration is successful.”    Such claims, however, completely ignore the fact that these blocking actions have been going on for decades.   The battle over potential drilling in a miniscule portion of the vast Arctic National Wildlife Refuge (ANWR)  started during the presidency of Jimmy Carter.   Had it not been block, the oil would have been flowing for several decades by now.

Then there is Obama’s effort to end the “unwarranted tax breaks.” Whatever merit of these tax breaks, it is unclear at best, how raising taxes on oil companies will help reduce costs.  In fact it is a little incoherent as any tax increases would simply be passed on to consumers driving prices even higher! More likely this is just another example of political opportunism rather than any serious concern for high gas prices; in the words of Obama’s former chief of staff Rahm Emanuel,  “Never let a serious crisis go to waste. What I mean by that is it’s an opportunity to do things you couldn’t do before.”

There one possible difference with the oil prices this time:  inflation.   As I warned in Preserving Democracy, over the last few years we have “increased the money supply 10 times more than the next largest increase over the last 50 year.” (p. 263) Since that warning we have printed even more money, tripling the money supply.  The normal result of such printing is inflation, and there can be little doubt that inflation is on the rise.

The Federal Reserve hopes to decrease the money supply as the economy begins to recover, but before inflation can kick in.  To believe they can do this is to believe that they can do something on a very large scale that they have not been able to do on a far smaller scale.   It is like believing that someone who has crash every time they have tried to land a small plane can now be trusted to land a jumbo jet full of passengers.

Inflation is the scariest of the factors driving up oil prices, because once started it will be the hardest to deal with. In addition, given the unprecedented amount the money supply has been increased, we can likewise expect unprecedented inflation, at least unprecedented in this county. As J. Kevin Meaders summarized it:

With the tripling of the money supply, cold mathematics would imply that eventually prices will likewise triple — once the new money has made it out into the economy. Thus, $3.50 gas becomes $10.50 gas. Clearly the math is not as easy as that, because really no one (especially Bernanke) can predict what will happen; but if history is any guide, then all of a sudden, $7 gas seems like a deal.

Thus while there are a lot of factors driving the increase in gas prices, it truly would be insane to one again try to demonize the oil companies, while ignoring the real factors driving up prices.

Note:  this is an updated version of a similar post from 2007.