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WebMemo #827 on Energy and Environment

September 1, 2005

A Bad Response To Post-Katrina Gas Prices

By

With the effects of Hurricane Katrina sending gas prices to new highs, politicians across the country are looking for easy answers. Some politicians are threatening action over "price-gouging" in Louisiana, and another state, Hawaii, is about to take the most direct action possible-it is implementing a 2004 law setting price limits on gasoline. At first blush, setting prices may seem like a sensible solution. But the United States has tried oil and gasoline price controls before, when the federal government implemented them in the 1970s, and they were an unmitigated disaster. In fact, the attempts by Washington to force down prices during that decade backfired so badly-resulting in shortages and gas lines-that they should have served as a permanent cautionary tale. Policymakers should leave the market to do what it does best: allocate limited resources to their most valuable uses.

 

Many remember the high prices and gas lines of the 1970s and blame the OPEC oil embargo and the effects of the Iranian revolution. But in truth, we were our own worst enemy. Begun by President Richard Nixon, but retained by Gerald Ford and made more complex under Jimmy Carter, the government set limits on the price of oil, as well as some limits on gasoline prices.[1]

 

By setting prices below market levels, the government made it unprofitable for market actors to respond to high prices in the usual way-by increasing production. The unintended (but predictable) effects were inadequate supplies and fuel shortages. Then, rather than lifting the price controls, the government tried to fix the problem by imposing allocation controls. Soon, we had centrally-planned programs determining how much of various fuel types to produce, how much to send to each state, and how much various categories of purchasers were allowed to buy. Thanks to the feds, we were not producing enough fuel and were doing a lousy job distributing it.

 

Government intervention became a vicious circle of one ill-conceived dictate after another, hurting the driving public and the overall economy at least as much as the actions by OPEC countries. As one energy analyst noted about the Iranian revolution,

 

The gasoline shortage was very small, perhaps 3 percent. Absent price control, there would have been a price increase, less than what actually occurred. But given price control, there had to be allocation: product by product, week by week, place by place … Scattered shortages led to hoarding and panic buying and worse shortages yet-and those gasoline lines. No other consuming country cooked up this kind of purgatory for itself.[2]

 

It was not an easy time for energy companies, but consumers, the supposed beneficiaries of price controls, suffered the most. As two leading energy analysts put it, "In hindsight, the confusing swirl of regulations that the government spewed out during the 1970s oil crisis gave consumers the worst of both worlds-higher prices and shortages."[3]

 

In 1981, President Reagan, in one of his first acts in office, swept away those price and allocation controls and restored a more free petroleum market. Prices soon dropped (and remained relatively low until recently), and the gas lines disappeared. For the next two decades, nobody thought seriously about repeating the mistakes of the 1970s.

 

Until now. Thanks to a 2004 law set to take effect in September, Hawaii will institute price controls. The Hawaii law has its own quirks that distinguish it from past measures. For one thing, it applies only to the wholesale price and is designed to ensure that the price in Hawaii is no different than that on the mainland (due to logistical costs and higher state gasoline taxes, Hawaii's gas is usually more expensive). Nonetheless, if the controlled price is below the market price, the end result will be the same as it was across the U.S. in 1973 and 1979. We will likely see gas lines in paradise, and because the retail price is uncontrolled, we may also see price spikes there as well.

 

Perhaps it is a good thing, at least for the other 49 states, that Hawaii is willing to provide a timely reminder that price controls do not work. After all, it has been a quarter century since the federal government last made that mistake, and many of today's drivers are too young to remember odd-even days, 10-gallon limits, and "Out of Gas" signs.

 

Congress will return after Labor Day, and the impact of Katrina on gasoline prices is sure to be high on the agenda. Even President George W. Bush has spoken out about gasoline "price-gouging" in Louisiana and implied that the government will intervene-presumably by setting some price cap. This would only serve, however, to reduce the availability of gasoline in the hurricane-ravaged region and make things worse. Hopefully, Washington remembers the lesson about price controls that Hawaii is set to relearn the hard way.

 

Ben Lieberman is Senior Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.



[1] For a more detailed discussion of these measures, see James B. Ramsey, "The Oil Muddle: Control vs. Competition," Ethics and Public Policy Center, 1981.

 

[2] M.A. Adelman, "Limiting Oil Imports," testimony before the Subcommittee on Energy Regulation, U.S. Senate, 96th Congress, 1st session (U.S. Government Printing Office, 1980), p. 95.

 

[3] Robert Bradley, Jr. and Richard Fulmer, Energy: The Master Resource, 2004, Kendall Hunt Publishing Co., p. 98.

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