From the windows of the blue line train, carrying me from my Hotel to the Midwest Political Science Conference downtown, I could see the price of gas at several Chicago service stations. It was well over three dollars. Facing a midterm election in November, Republicans have prodded President Bush into action. From the Washington Post:
Amid growing Republican unrest about the politics of $3-plus gasoline, Bush told the Renewable Fuels Association he will take the unusual step of suspending shipments to the nation's Strategic Petroleum Reserve to boost supply and help hold down oil prices. The president also said he will temporarily ease environmental regulations that require the use of cleaner-burning fuel additives to cut down on summertime pollution. Still, according to industry experts and administration officials, Bush's efforts at best are likely to shave a few cents per gallon off the cost of gasoline.
In the short run this had had some effect. Again from the WaPo:
Light sweet crude for June delivery settled 45 cents lower at $72.88 a barrel on the New York Mercantile Exchange, dropping on the heels of a 4.48-cents-per-gallon decline in May gasoline futures, which finished at $2.1291 a gallon.
These are more than marginal drops, but they are unlikely to be sustained. Bush has also taken the politically expedient but substantively meaningless step of casting a suspicious eye toward the evil oil companies.
Under pressure from GOP leaders, the president is taking a tough public line with the U.S. oil companies that are recording record profits and paying hefty salaries and retirement packages to executives. Bush ordered three federal agencies to investigate whether companies are manipulating the cost of gasoline -- boosting prices as many report record profits. The administration asked state governments to do the same.
He probably has no choice but to dance this dance, but it has nothing to do with the actual price of oil. Oil is a commodity. Its price is determined over the long run by the balance between supply and demand. At any one moment it is determined more by the expectations of traders. Two basic facts are influencing their decisions. One is that global demand is steadily rising. The strong economy in the U.S. will increase the thirst for oil. In addition, the dramatically growing economies in China and India are taking progressively larger cuts out of the world oil supply. So much for demand.
Oil traders have a lot to worry about when it comes to supply. Political turbulence in the Middle East, including Iraq and Iran threaten important sources of oil. Similarly, political instability in Nigeria and the erratic government of Venezuela raise questions about the reliability of these important sources of crude. The Southern U.S. and Mexico have still not recovered from Hurricane Katrina.
So why are oil companies raking in the profits? Economics 101. The commodity they produce is rising in value. So shouldn't they give a little back to the children on their motorized scouters by keeping prices low? No. The oil industry has a lower profit margin than most industries, in large part because their business is expensive, and they reinvest a very large part of their profits in new sources. Or at least they do when prices make new exploration and development economically viable. Moreover, higher prices ensure that when the supply is tight, it goes to the most desperate buyers. If prices remain high, car buyers will shift to more economical vehicles, and the auto industry will oblige by producing and developing more of the same.
This is basic economics and, like it or not, there is no way to escape it. Government could respond by punishing the oil companies or, more robustly, by instituting price controls. We know exactly what will happen because we have been through all this before. Artificially cheap oil will be consumed fast, and shortages will result. The Bush administration will not take this route because the only thing more irritating than high gas prices are long lines at the few stations that have gas to sell.
The prosperity of the last several decades has been fueled by cheap oil. I suspect that the era of cheap oil will continue for some time as new sources are exploited, but it won't last forever. Complaining about the greed of oil companies make make us feel good, but it is no substitute for developing new sources of energy.
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