Does the Gas Tax Belong in the Fiscal Cliff Fix?

Recently I've seen several articles along the lines of this one from CNN, suggesting that an increase in the federal gasoline tax might be included in negotiations to avert the impending US "fiscal cliff".  While the gap between the gas tax, which was last raised in 1993, and highway repair costs grows each year, that's not just because past Congresses and administrations have been reluctant to hike it again.  As I've discussed in previous posts, gas tax revenue is declining for structural reasons related to curtailed driving, rising fuel economy and alternative fuel vehicles.  Simply adding another 10-15 ¢ per gallon to the current 18.4 ¢ tax wouldn't solve the long-term problem, although it would raise enough revenue to allow us to continue to ignore these growing challenges for a few years.  For that and other reasons, changing the gas tax deserves closer scrutiny than the waning hours of a preoccupied lame-duck Congress can provide.

Yesterday I attended another excellent event held by Resources for the Future in Washington, DC.  This one was devoted to "The Future of Fuel."  The panel discussion began with a presentation of the current energy forecast of the Energy Information Agency (EIA) highlighting the shifting energy mix the agency expects between now and 2035.  Although the slide deck didn't include the chart below, taken from EIA's 2012 Annual Energy Outlook, I couldn't help thinking of it in the context of both yesterday's meeting and the question of future fuel tax revenues. 

The EIA forecasts US gasoline demand to decline by about 8% from current levels by 2035 as cars meeting the new federal fuel economy standard enter the fleet, along with small but growing numbers of vehicles running on electricity and other non-petroleum fuels. An 8% drop in gasoline sales--and thus gas tax revenues--doesn't sound large until you realize that the current gas tax system was predicated on consistently rising gasoline sales as a means of expanding revenues. That's crucial, because highway construction and maintenance costs rise each year, too.  If gasoline sales were still growing at the 1% annual rate typical when the gas tax was last increased, gas tax revenues would be at least 37% higher by 2035 than the level the EIA would now project.

Stepping back from the details, the government faces a fundamental disconnect between its need to raise sufficient funds from the gas tax to cover the cost of maintaining the nation's road network and explicit federal policies aimed at reducing our consumption of the fuels being taxed.  Another one-time bump in the gas tax, whether of 5¢, 10¢ or 15¢ per gallon, will again be overtaken by the combined forces of inflation and declining volumes.  Fortunately, this problem is well-understood and a number of solutions are under consideration.  Inconveniently, many of them involve basic and controversial changes in how the road tax would be collected, such as shifting to a mileage-based tax assessed via annual inspections or real-time GPS monitoring. 

No one should expect or desire the 112th Congress to resolve these issues between now and the end of its term in January, particularly when the money at stake represents such a tiny fraction of either the fiscal cliff's package of tax increases and spending cuts or of the entire federal deficit.  I'm also not sure that reforming the gas tax belongs within the larger federal tax reform effort that should be undertaken next year, because the issues involved are so different from those associated with revamping the business, income, and payroll taxes.  Even a temporary fuel surtax would likely encounter strong opposition, due to its regressive nature and coincidence with gasoline prices that, despite recent declines, remain at or near seasonal record highs.  Unlike the rest of the fiscal cliff, this might just be one can that would benefit from being kicked down the road, at least past the current crisis.

EPA Unwavering in Support for Ethanol, Despite Drought

Last Friday the US Environmental Protection Agency (EPA) rejected the petitions of a bi-partisan group of state governors for a waiver of the federal ethanol mandate, resolving one of several energy-related issues that had been deferred beyond the presidential election.  The waiver requests filed in August cited the harm that the Renewable Fuel Standard (RFS) is causing to the poultry, dairy and livestock sectors and related businesses--and by extension to consumers--by increasing competition for corn during a severe drought that has sharply constrained supply.  The EPA's detailed response made frequent references to the "high statutory threshold of severe harm to the economy" required for a waiver of the RFS, and to the output of a model simulating the market for corn and ethanol. It also included the extraordinary assertion that, "the RFS volume requirements will have no impact on ethanol production volumes in the relevant time frame, and therefore will have no impact on corn, food, or fuel prices."  If that were true, then it's not obvious why the mandate should exist at all.

In rejecting pleas for relaxation of the ethanol standard, the EPA appears to be relying on two key facts.  First, wholesale ethanol prices remain lower than wholesale gasoline prices, despite corn prices that are high enough to force many ethanol producers to cut back output.  I'd attribute that mainly to weak US gasoline demand and the much-discussed impact of the "blend wall" in limiting ethanol to 10% of the gasoline pool, rather than as a sign of an unaffected market.  The agency is also relying on the availability of "paper ethanol" in the form of Renewable Identification Number (RIN) credits from past over-blending of ethanol by refiners and other gasoline blenders.  The EPA's estimate puts the number of available RINs at the equivalent of 2-3 billion gallons, or around 20% of this year's 13.2 billion gallon conventional ethanol requirement. As a result of these factors, EPA can claim with some justification that ethanol prices are not harming motorists at the gas pump at this time.  That's small consolation to the petitioners.

EPA's assurances to those in the poultry, dairy and livestock value chains are based on much thinner evidence--in fact, on none at all, unless you count as evidence a model that predicts corn prices would only fall by $0.58 per bushel if the ethanol mandate were eliminated entirely.  Simulations are useful but still aren't reality. The output of a model is only as good as its assumptions and algorithms, and when that output defies logic, it calls for the application of good judgment, particularly when the result happens to align so neatly with the internal concerns about the long-term implications of a waiver that are evident in the agency's response.  I can't help concluding that an agency whose management possessed greater depth and breadth of experience outside of government--especially in the business sector--would have given more weight to the struggles of the dairies, ranchers, meat-packers and others who are being squeezed by a mandate that is projected to consume 42% of this year's corn crop and is very likely inflating the cost of the Thanksgiving meal that many of my US readers will eat on Thursday.   This administration's lack of outside experience has been a glaring shortcoming that the President could easily remedy as turnover creates openings at the start of his second term. 

I can't say that I'm surprised by the EPA's ruling on the waiver requests.  I also can't help wondering whether it provides any indication of how the administration is likely to deal with the other issues that were deferred until after the election.  Yet even if we can't read anything else into this decision, it's clear that the Renewable Fuel Standard enacted in 2007--before the financial crisis and recession--is in serious need of reform.  If its language doesn't require the EPA to adjust the ethanol mandate in light of a drought that will result in the smallest corn crop since 2006, when US ethanol production was 65% lower than last year, then the law simply didn't incorporate sufficient foresight about possible future events.  Together with its unrealistically ambitious cellulosic biofuel standard, the provisions of the RFS increasingly seem to relate to some other, parallel universe, rather than the one in which we live.  

Is Gas Rationing Superior to Raising Prices for Consumers?

With New Jersey about to end the odd-even gasoline rationing  imposed in the aftermath of Hurricane Sandy, we have an opportunity to consider whether this kind of response actually produces better outcomes than the price increases by which the market would normally balance supply and demand.  Most of the defenses of "price gouging" that I've seen, including Matthew Yglesias's recent posting in Slate, tend to focus mainly on its supply-side aspects. Yet such arguments, however well-reasoned, are unlikely to sway Americans from their innate sense of fairness, on which most anti-gouging regulations are premised.  That's inherent in the judgmental term itself.  However, having spent my share of time in gas lines during the energy crises of the 1970s, I believe that supporters of these rules are ignoring some even more pragmatic, consumer-based arguments for allowing prices to rise after a disaster.

In addition to the tragic loss of life and property inflicted by Sandy, the storm left the petroleum products infrastructure on which New Jersey depends paralyzed for days.  Refineries were shut down, distribution terminals full of gasoline were unable to deliver product, and gas stations without power had no way to sell the fuel stored in the tanks under their forecourts.  This combination represented a huge supply shock to the region, and it wasn't long before gas lines formed at those stations that had both product and electricity.  New Jersey has strict and specific anti-gouging rules and is already charging merchants with violations following Sandy.  Within a few days, in an effort to alleviate the queuing that resulted from the supply shortfall and the inability of retailers to raise prices, Governor Christie resorted to rationing by license plate number.

Although restricting prices might superficially appear more equitable--particularly for lower-income consumers--than allowing them to climb to the levels necessary to clear the market without long lines, it also imposes significant costs on all consumers.  For starters, anti-gouging rules effectively confine motorists to their vehicles precisely when they have many other urgent priorities, including attending to their families and homes. They also implicitly put a very low monetary value on consumers' time.  Waiting on line for four hours to obtain 10 gallons of gas at a pre-disaster price of $3.50/gal., instead of experiencing a much shorter wait to purchase fuel for $5.00/gal., is equivalent to being paid $3.75 per hour--around half the state's official minimum wage.  This situation also increases the chances that an individual will wait for hours only to see the station run out of fuel before his or her turn comes, because demand is unchanged or temporarily higher than before the crisis.  Adding odd/even rationing might reduce gas lines by limiting demand and breaking the psychology contributing to the lines, but it also compounds the harm to consumers, some of whom are left with no legal means of acquiring fuel when they need it most.

I don't expect politicians and regulators suddenly to embrace a purely market-based approach towards post-disaster pricing of necessities like fuel.  However, we ought to expect them to look at the real-world results of their policies and apply some common sense and creativity to improve how they function.  Anti-gouging rules clearly benefit some at the expense of others. How could we simultaneously preserve the benefits for the first group, while allowing those willing to pay a premium for emergency supplies to do so, in the process sending the appropriate price signal to reduce overall demand? One solution might be to allow gas stations with multiple pump islands to raise prices as long as they have at least one set of pumps offering the pre-disaster price.   Technology should provide even more innovative and effective options.

Given the magnitude of the supply disruption post-Sandy, there was no way to avoid a serious shortage of motor fuel in the affected region.  However, the appearance of long gas lines and the resort to a 1970's expedient of odd-even rationing shouldn't satisfy anyone concerning the effectiveness of the pre-existing emergency energy policies that were called into play following the storm.  I can't imagine New Jerseyans being content with the outcome they experienced.   

Push-me/Pull-you: Post-election Energy Policies

I've seen numerous commentaries on the energy implications of President Obama's narrow, 51%/49%  victory. One of the most intriguing of these, from Reuters, concerned the prospects for exporting a portion of the growing output of natural gas produced from US shale deposits.  This issue doesn't only affect gas drillers and their residential and industrial customers, but also developers of renewable energy projects, because of the way that gas and renewables compete in electricity markets.  As much as the President's reelection, the failure of Republicans to capture control of the US Senate might turn out to be a key factor in determining the fate of potential gas exports, and by extension the environment within which renewables like wind and solar power must compete.

A variety of energy issues has been in limbo for months, pending the outcome of Tuesday's election.  That includes approval of the Keystone XL crude oil pipeline from Canada, which might have gotten a favorable nudge as a result of Senate wins by pro-pipeline Democrats in North Dakota and Montana.  Environmentalists are committed to blocking the pipeline, so the President must soon choose which part of his winning coalition he will disappoint.  By comparison, the question of natural gas exports has received much less attention in the media, although it's been discussed extensively within energy and manufacturing circles.  The likely incoming chairman of the Senate Energy and Natural Resources Committee, Ron Wyden (D-OR), appears to have strong views on the subject.   

If Senator Wyden does replace the outgoing chairman, Senator Bingaman (D-NM), as expected, this would represent a shift in constituencies from a state with significant oil and gas production to one with essentially none.  Senator Wyden thus brings mainly an end-user perspective to his Energy and Natural Resources role, and from that standpoint his concern about the potential price impact of gas exports, whether in the form of LNG or otherwise, is understandable, although I would argue it is also short-sighted and potentially detrimental to renewable energy, which he strongly supports.

On the surface, restrictions on the export of US gas should result in lower domestic natural gas prices than if large quantities of gas were shipped offshore.  After all, low US natural gas prices, compared to those in Europe and Asia, are the main driver behind the desire to build export facilities, such as the Sabine Pass project of Cheniere Energy.  Natural gas is cheaper in the US than elsewhere for several reasons, including the high and growing output from shale gas resources, as well as the epic disconnect between the natural gas price and crude oil prices, which are the basis for most international LNG contracts. US gas at the wellhead is currently trading for the oil equivalent of $21 per barrel, compared to UK Brent Crude at $107 per barrel.  The extent to which exports might increase domestic prices is a matter of much speculation and study, and I wouldn't venture a guess.  However, we can't just look at demand in gauging the impact of export restrictions.

The efficacy of holding down US prices by keeping more gas here also depends on the response of producers.  If legislators or regulators turn the US gas market into a capped bottle, why would producers be content to supply steadily increasing quantities of gas at prices that don't provide them an attractive return?  To some degree the low prices we've seen this year were the result of the combination of a weak economy and a supply glut created by contractual commitments on the part of drillers to develop gas leases at a specified pace.  My understanding is that most such commitments have lapsed, and that a significant proportion of current gas supply is coming from wells that depend on the economics of their liquids output (crude oil and gas liquids), with the associated natural gas effectively a byproduct.  It's not clear how rapidly gas production can continue to grow without natural gas prices that make gas-only wells economically attractive.  So a US gas market with no export outlets would likely produce less gas in the long run, and that would constrain opportunities to use our abundant gas resources to support new industries, displace oil from transportation, and further reduce the use of coal in power generation.

Moreover, keeping a lid on the US gas market would compound the obstacles for renewable sources of electricity.  Wind power developers and turbine manufacturers now face the expiration of the Wind Production Tax Credit (PTC).  Even if it is extended, the output of wind farms competes with the output of gas turbines, while the grid relies on gas-fired power to provide a back-up for the intermittent output of wind and solar power.  The cheaper the gas, the tougher it will be for renewables to make a profit. Market competition with gas will become an even bigger issue for renewables as they expand beyond the capacity of a cash-strapped federal government to continue to subsidize them.  The one-year extension of the PTC under consideration could cost as much as $12 billion, an annual price tag that would only grow as renewables scale up--as they must if they are going to matter.

Navigating the complexities of allowing or restricting natural gas exports, and balancing the various constituencies involved, could provide an early test of the administration's commitment to an all-of-the-above energy strategy.  That's because "all of the above"--if not merely a slogan--implies more than just producing energy from a variety of sources.  It also entails competition among all these sources within a market in which some sectors of demand are declining, others growing, and new ones--including exports--are appearing all the time.  Pushing back on one part of this market will have large consequences in other parts, and regulators could soon be overwhelmed by unintended consequences.