Gas Costs Too Much; Here’s Why

COMMENTARY Environment

Gas Costs Too Much; Here’s Why

Feb 29th, 2012 2 min read
Nicolas Loris

Deputy Director, Thomas A. Roe Institute

Nick is an economist who focuses on energy, environmental, and regulatory issues as the Herbert and Joyce Morgan fellow.

Gasoline is in plentiful supply. Demand is falling. So why are prices at the pump going through the roof — up nearly 30 cents a gallon in the past month alone?

A number of reasons, actually. Most of what dictates the price of gas is the price of oil. The Energy Information Administration reports that in January, crude oil prices accounted for 76 percent of the price of a gallon of gas. Excise taxes, refining costs and retail/distribution made up the rest.

Crude is sold in the global market. Though U.S. demand has fallen because of a weak economy and a warm winter, China and India are buying crude at a blistering clip. Asia surpassed North America as the world’s largest petroleum-consuming continent in 2008. And that consumption will only increase as China’s and India’s economic growth continues to outpace ours.

Increased demand from Asia has steadily pushed up oil prices. But recently, other factors have conspired to drive prices even higher. The most notable of these: Iran’s threat to restrict oil exports to Europe and block the Strait of Hormuz, causing producers to stockpile in case of a major supply disruption.

Such a dramatic announcement also fuels speculation. When the market anticipates higher prices in the future — say in Europe — producers may take some oil off the market and wait to sell it later. But speculators and producers cannot control long-term pricing. At some point, they have to unload their inventories

(Note to Congress and the president: Just as speculators can drive up prices near-term, so they can drive down near-term prices on expectations that more oil will reach the market. Moral: New drilling can affect the price of oil sooner than the 10 years it may take for the crude itself to reach the market.)

The Federal Reserve also deserves its share of blame. Oil trades in U.S. dollars, and the Fed’s easy-money policy has weakened the value of the dollar. It now takes more dollars to buy the same amount of oil in the U.S.

Many people want to blame the Organization of Petroleum Exporting Countries because the cartel sets production targets based on estimates of future supply and demand. Fortunately, OPEC is not a very strong cartel. Member countries often ignore production targets and produce more to capture more profit. Currently, OPEC’s output is at a three-year high.

Washington could nudge gas prices lower if it wanted. For starters, the administration could reverse policies that have led speculators to believe Energy Secretary Steven Chu still clings to his 2008 position that, “Somehow, we have to figure out how to boost the price of gasoline to the levels in Europe,” where it costs $8 to $10 a gallon.

To reverse course, Congress and the administration could announce they will:

• Open to leasing and exploration the federal lands and offshore areas they have closed.

• Speed up the drilling permit process — which they have been slow-walking since 2010.

• Approve entire the Keystone XL pipeline to transport oil from Canada.

Can that really make a difference at the pump? Yes. The mantra of the anti-drilling crowd is that oil production takes seven to 10 years, so why do it? The longer politicians listen to that message, the longer the nation’s oil resources will remain undeveloped.

We can increase production this year simply by streamlining the permitting process for federal lands and waters. The Keystone XL pipeline could bring Gulf Coast refineries up to 830,000 barrels of Canadian oil every day by next year if the president would green-light the project.

The energy market can work for consumers as well as producers, but only if Washington lets it work. Oil companies would increase production, and consumers would buy the most fuel-efficient vehicles that fit their needs and pocketbooks. If the price of gasoline continues to rise, it will make alternative technologies all the more economically competitive. But policies that restrict oil exploration, refining and production should not artificially drive that price higher.

Nicolas Loris is the Herbert and Joyce Morgan Senior Research Fellow at the Heritage Foundation.

First appeared in The Washington Times