Wednesday, September 14, 2005

Misplaced Outrage

At the same time the country is absorbed with efforts to assign responsibility for the tragically confused post-Katrina rescue effort, another "blame game" is playing out: why are gasoline prices so high? Despite the evidence supporting a simple answer having to do with the nearly instantaneous loss of 10% of the country's oil refining capacity, and the need for higher prices to balance a market that was suddenly facing a shortfall of a magnitude not seen in several decades, the noises coming out of various state governments seem to be emanating from a parallel universe.

I'm going to use the example of my own state, Connecticut, but I'm sure you can find similar discussions going on in nearly every other state. According to my local paper, the Attorney General of Connecticut, Richard Blumenthal (D), is apparently surprised by the speed and magnitude of the price response. He sees it as evidence of at least a lack of competition, if not actual collusion. He regards high oil company profits as further evidence of this. In response, he is calling for an investigation into the operation of the New York Mercantile Exchange, where crude oil, gasoline and heating oil futures trade, and calling for an excess profits tax on oil companies.

Anyone looking for a partisan slant to this line of thinking will be disappointed. State Representative Lawrence Miller, R-Stratford, provided the quote of the week, "I've heard a lot about looting since the hurricane. But I think the real looters up here are called the Mercantile Exchange of New York. Hearing about $4 a gallon is unreasonable and unacceptable."

Now, when I think about these comments, I am torn over whether to ascribe them to ignorance or profound cynicism. Is it really possible that these gentlemen understand so little about how markets work, and about how petroleum products reach consumers, that they can ignore the evidence of photos of drowned refineries and pursue rabbit trails of conspiracy, at public expense? But, as I've suggested before, it is easier and more expedient to feed public outrage over high prices than to explain that this is actually how markets work.

We need to keep clearly in mind that we have two basic choices for how we want the gasoline market to function:

  1. Allow the market to move in response to changes in supply and demand, with price as the mechanism by which balance is achieved, or
  2. Impose constraints or actual rationing, involving price caps, odd-even days, gallon limits on fill-ups, etc.

We have experienced two major crises that offer excellent examples of how each of these approaches works. Choice Number 1 has operated throughout the Katrina Crisis. Despite starting with very low inventories, the gasoline supply system has rebalanced at a higher price, and gas lines only appeared in communities that suffered a direct loss of physical supply. These quickly abated, when pipeline deliveries resumed. Choice Number 2 was tried from 1973-1981, and it resulted in widespread gas lines, enormous productivity losses, grotesque distribution inefficiencies, and a nearly universal desire to deregulate markets.

In fact, it was the installation of Choice Number 1 in 1981 that set the stage for two decades of gasoline prices that consistently lagged the national inflation rate, until surging global oil demand and a series of supply disruptions, including wars and strikes, set prices on their current upward path, starting in 2002.

The biggest problem with the market option, of course, is that someone makes money on it. That puts us in mind of gouging and profiteering, rather than thinking about the Herculean efforts performed behind the scenes to make the outcome as seamless as possible for consumers. Our officials should spend more time thinking about how to mitigate the impact of high prices on those least able to bear them, and less on how to tamper with the means of ensuring reliable supply. That's not as glamorous, or as ambition-advancing, but it would serve their constituents' interests much better.

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