Is Gasoline Cheaper Than Water?

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by Dom Armentano: Capitalism
and the Wall Street Protesters



Think gasoline
prices are historically high? Think that there is no competition
in the petroleum industry? Think that the oil companies earn a "monopoly"profit
selling gasoline? Well think again.

When Ronald
Regan took office in January of 1981, gasoline sold for approximately
$1.40/gallon. Prices fluctuated up and down over the next 20 years
but gasoline prices were still roughly $1.40 when George W. Bush
was elected in 2000. After 2001, gasoline prices increased steadily
and hit almost $4.20 in the summer of 2008; then prices fell back
dramatically to around $1.75 in early 2009. Since then gasoline
prices have risen to $4.00/gallon in April, 2012.

Is this pricing
pattern over the last 30 years necessarily indicative of monopoly
power, price gouging, or a total lack of competition in the oil
industry? Hardly. Indeed, when we overlay gasoline prices with the
price of crude oil over these very same years, there is almost a
perfect fit. And since domestic oil refiners don’t control the international
crude oil market, and since crude is the major (67%) cost component
in gasoline refining, gasoline prices likely reflect the true costs
(including the risk costs of supply interruptions) of producing
and delivering refined product to consumers.

Federal and
state taxes also play a role in gasoline pricing. When consumers
purchase gasoline at the pump, they automatically pay a federal
excise tax of 18.4 cents/gallon and an average state sales tax of
27.2 cents/gallon(far higher in California) for a grand total of
45.6 cents/gallon on average. Thus excise taxes alone account for
almost 12% of gasoline prices at retail. On the other hand, the
industry-wide gross profit margin for selling gasoline is 2.5% or
roughly 10 cents/gallon while Exxon-Mobil, the largest domestic
oil refiner, earns about 3 cents per gallon from all of its refined
products sold in the U.S.

Critics charge
that oil companies are "greedy"and "charge what the
traffic will bear." The fact remains that all market participants
are greedy (consumers as well as sellers) and that all sellers,
depending upon their competition, charge what the traffic will bear.
Yet despite oil company self-interest (I would say because of it),
the price of a gallon of gasoline is still roughly equal to the
price of some bottled waters and, indeed, far cheaper than most
premium brands like Evian ($7.49/gallon). Gee, I guess water companies
must be greedier than oil companies.

Still another
way of demonstrating that gasoline prices are not monopoly prices
is to adjust gasoline prices for the general rate of inflation over
time. After all, if gas prices simply reflect a decline in the value
of the (dollar) currency, it would be wrong to conclude that prices
are higher simply because of so-called monopoly.

When we adjust
gasoline prices for inflation (in 1979 dollars), a gallon of gasoline
cost roughly $1.20 in 1981, declined to 60 cents in 1999, rose to
$1.40 in 2007 and is approximately $1.38 today. Thus in real price
terms — that is nominal prices minus the rate of inflation — a gallon
of gasoline that you bought yesterday at the local station is only
marginally more expensive than it was when Ronald Regan became President.
That’s monopoly power?

Critics would
have you believe that the oil industry is not purely competitive
because the bulk of the production is accomplished by 6 super major
oil companies (even though there are 143 domestic oil companies).
The first charge is bogus since pure competition is an intellectual
fiction and exists in absolutely NO industrial situations. The second
contention is true but irrelevant to an understanding of how large
firms actually compete.

Oil companies,
like all large industrial firms in legally open markets, engage
in a vigorous competitive process where they must perform efficiently
for stockholders and sell an improved product to willing buyers
every day…else they lose market share to a rival. This process of
rivalry is an explicit manifestation of Adam Smith’s "invisible
hand"and is alive and well in oil refining. Critics that really
want to understand monopoly power had best turn their attention
from the phony issue of oil industry "concentration"to
the real monopoly problem: the government-run OPEC cartel that nationalizes
crude oil resources, controls crude oil production, and keeps costs

Consumers don’t
like paying higher gasoline prices; we can certainly sympathize
with that. But economic history teaches that the oil industry has
always been workably competitive and that market prices tend to
reflect market costs in the long run with a modest rate of return
for suppliers. The problem, as usual, is government. The best that
public policy can do is to remove legal or regulatory barriers that
restrict production (fracking, drilling, pipeline and exploration
delays) or abandon policies that artificially inflate industry costs
including taxes and the risk-costs of new or expanded wars.

19, 2012

Armentano is Professor Emeritus at the University of Hartford (CT)
and the author of Antitrust
and Monopoly

(Independent Institute, 1998) and Antitrust:
The Case for Repeal

(Mises Institute, 1999). He has published articles, op/eds and reviews
in The New
York Times, Wall Street Journal, London Financial Times, Financial
Post, Hartford Courant, National Review, Antitrust Bulletin
and many other journals.

Best of Dom Armentano

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