May 4, 2006

May 4, 2006 | WebMemo on Energy and Environment

Avoiding Backfires at the Pump: How to Handling High Gas Prices

Congress has a wide variety of proposals for dealing with high gasoline prices, but it is easy to distinguish the good ones from the bad. The good ideas recognize free markets as the best deal for consumers over the long run, while the bad ideas resort to taxes, regulations and other forms of government interference with those markets. Despite the difficulties of getting things done in an election year, Congress should do everything it can to advance the good ideas and put a quick stop to the bad ones.

 

Good Ideas

 

Increase Domestic Oil Production: Simply put, America is not making full use of its own oil potential.  Many promising areas are currently off-limits to exploration and drilling. These areas include Alaska's Arctic National Wildlife Refuge (ANWR), which has an estimated 10 billion barrels of recoverable crude on a small portion of it, and 85 percent of America's offshore areas which contain much more crude oil. These areas will not provide enough domestic oil to end imports or put OPEC out of business, but they will provide more than enough to make a noticeable difference in price for decades to come. 

 

The current restrictions were imposed years ago when oil was cheap and the need for additional production was not seen as significant. Efforts to repeal these measures were taken out of the final version of the Energy Policy Act of 2005. Fears of environmental damage from drilling have kept the restrictions in place, though technological improvements have greatly reduced those risks and all new drilling will have to comply with strict safeguards. It is time to change the outdated laws constraining the domestic oil industry and get America pumping again.

 

Increase Refining Capacity: Compounding the high price of oil is the high price of turning that oil into gasoline. This is due in part to refining capacity that is barely adequate to the task of meeting the growing demand for gasoline. Even under the best of circumstances, refiners strain to provide enough fuel, especially during the high-demand summer vacation season. And, there is no cushion of spare capacity when refineries are damaged by hurricanes or other adverse events. 

 

Costly and time-consuming environmental regulations, along with other factors, make construction of a new refinery all but impossible and hamper expansions of existing ones. Many of these regulations are redundant, and some have proven counterproductive by discouraging facility upgrades that could actually reduce emissions. These regulations need to be streamlined so that the domestic refining sector can better respond to the needs of a growing economy. 

 

Streamline Fuel Regulations: There are so many different types of gasoline across the United States, experts can't even agree on the exact number. The Environmental Protection Agency says there are a dozen, but pipeline operators report having to deal with more than 30. Some of these blends are mandated by the federal government, while others are imposed by states. Several are more expensive to produce, and the logistical burden of having to separately refine, transport, and store so many non-fungible varieties adds to costs and increases the likelihood of localized shortages and price spikes.  The gasoline market, once an efficient national one, has effectively been balkanized. New provisions in last year's energy bill, particularly the requirement that ethanol be added to the fuel supply, have further complicated matters.

 

While some environmental standards for gasoline make sense, the patchwork of requirements that has accumulated over time has clearly reached the point of overkill and does more economic harm than environmental good. These regulations should be streamlined so that the nation's fuel market can operate more efficiently; this can be done without jeopardizing air quality.

 

End Government Interference in Ethanol Markets: The only alternative to petroleum-based gasoline and diesel fuel that has gained a significant foothold is corn-based ethanol, but it has done so largely through government help. Special tax breaks for ethanol, chiefly a 51 cent per gallon tax credit, have helped it reach a few percent of the US fuel supply. The domestic ethanol market also benefits from stiff tariffs on foreign ethanol.[1] The tariffs preclude cheaper ethanol, such as Brazilian sugar-based ethanol, from being imported in large amounts and undercutting the domestic market dominated by Midwestern corn farmers and agri-business giant Archer Daniels Midland.  

 

Thanks to the Energy Policy Act of 2005, the use of ethanol is now required. Starting this year, four billion gallons must be added to the fuel supply, and that will rise to 7.5 billion gallons by 2012. Unfortunately for consumers, ethanol adds to the price at the pump, and its use is contributing to the current increases.  

 

For this reason, Congress should end the domestic ethanol tax breaks and mandate. It should also end the tariffs and treat foreign ethanol no differently than the domestic variety. Experts disagree on whether ethanol can succeed on a larger scale as an economically viable alternative, but it ought to be given the chance without the federal government tilting the playing field in favor of domestic ethanol or against foreign ethanol.  Consumers would benefit if the market-not special interest politics-decides how much ethanol to use and where it should come from.

 

Bad Ideas

 

Change the Tax Code: The tax code is not the reason for $3.00 gas, and so the many proposals to tinker with the code won't really solve anything.   Anger at oil companies has led to many proposals to raise taxes on them, but doing so will do little to change the price at the pump, which is set by supply and demand.  Over the long term, higher taxes on the oil industry will hurt consumers because the taxes will discourage investments in increased production. We want an oil and refining sector that produces more, not less, in the years ahead, and lawmakers should keep this in mind before imposing punitive taxes.

 

Similarly, proposed repeals of the 18.4 cents per gallon federal gas tax or $100 rebate checks to Americans to compensate for higher gas prices are more gimmick than solution. They won't increase supplies whatsoever and would undercut the incentive to reduce demand.

 

Regulate Fuel Economy: Several proposals seek to raise the Corporate Average Fuel Economy (CAFE) standards for automobiles. Consumers would gain nothing by having the government step in and force this option on them. Fuel efficient vehicles, including a growing number of gasoline-electric hybrids, are already available for those who want them. And there is much to lose since that downsizing vehicles to meet tough new CAFE standards makes those vehicles less safe.  

 

Investigate the Oil Industry: Many politicians are demanding a federal investigation of the oil industry, as if oblivious that two such investigations are already underway.  Nor is there any reason to suspect any foul play-nearly every gas price spike over the past three decades has led to such investigations. They have all concluded that market forces and not illegal conduct can explain price spikes.

 

Nonetheless, nothing is wrong with the federal government once again checking to make sure oil companies are not illegally holding back on supplies or colluding to manipulate prices. But if nailing "big oil" becomes an obsession-as it has with some in Congress-it could become a blind alley that hinders consideration of more useful proposals.

 

Impose Price Controls: Washington can't repeal the law of supply and demand, and any attempt to do so will only cause harm. The market price of gasoline is the price where supply and demand balance out. Right now that price is high, but that is the market reality. Trying to force the price down below this level means that demand will outstrip supply at the mandated price. Accordingly, attempts at price controls in the 1970s inevitably led to shortages-gas lines, rationing, and stations running out. Most Americans would prefer that gas be available at the market price than unavailable at a lower price. 

 

In addition to explicit price controls, a number of bills have proposed new restrictions on "price gouging." To the extent such measures act as de facto price controls-wholesalers or retailers could be subject to legal liability if they charged the market price-the problems caused by these restrictions would be similar to those caused by price controls.


Conclusion

Unfortunately, the good ideas are hard to sell. They are long-term solutions that would do nothing  before the November elections, which are the focus of many in Congress.  In addition, and good solutions are frequently derided as environmental rollbacks or giveaways to the oil industry.  These attacks, although unfair, have kept the good ideas from being implemented. 

 

At the same time, many of the bad ideas have political appeal, especially those that seek to "get tough" on big oil companies at a time of both high gas prices and high industry profits. Even measures that have been tried in the past and failed badly are again gaining support. Bad bills are proliferating by the day.

 

One need look back no further than last year's energy bill to find a measure that is doing more harm than good for the driving public. Congress should be careful not to enact legislation that once again backfires at the pump.    

 

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



[1] Up to seven percent of domestic ethanol consumption can be imported duty free from certain Caribbean and South American countries, provided certain conditions are met. The rest is subject to a duty of 2.5 percent plus 54 cents per gallon.



About the Author

Ben Lieberman Senior Policy Analyst, Energy and Environment
Thomas A. Roe Institute for Economic Policy Studies