High Prices as Policy

The news of the oil price dip was all the rage yesterday, so let’s talk oil prices, hovering at $40 per barrel. In real terms, they are still below the peak, but four times higher than they were one president ago. What was everywhere known as the all-oil ticket became the oil presidency that has indeed yielded hugely high prices for oil.

"Cheap energy is how we got into this mess." ~ George W. Bush

Why and how? There are many explanations available for why oil prices are higher than they otherwise would be. We could list taxes, restrictions on drilling, regulations making new refineries prohibitively expensive, the war on Iraq, and many other factors. Melting down all these shackles would drive the price down dramatically, so that gas would be cheaper than water.

Even so, all these interventions (apart from the Iraq War) are not new. Why the price spike now? We are talking about an oil price that is higher (again, in nominal terms) than at the height of the Nixon-Ford inflation, when we all found prices intolerably high. Prices fell all during the Reagan years, thanks to the effects of Carter’s deregulation, and during most of the Clinton years as well. In fact, prices reached good-old-days levels at the very end of the Clinton era: $11 per barrel. Gas hovered at $1 a gallon, an historic low in real terms. Pure heaven!

In those days, some people in and out of government were very concerned about the fall in oil and gas prices. The environmentalists hated it, of course, for fear that lower prices meant more consumption and more consumption meant more industrialization, prosperity, and social happiness, which they somehow cannot stand. No, we should all pedal to work or ride mass transit or take air balloons or something. There was enough realization within the Clinton administration that such a policy would be politically devastating to keep that agenda somewhat at bay.

Who else worried about low gas prices? It was four years ago last month that Richard Cheney appeared on “Meet the Press” to called for a “national energy policy.” He told Tim Russert that oil prices were “too low” and that “no one will invest” in oil wells at such prices. He added that prices that are too high can be harmful as well. Russert smartly asked: “What is the correct price of oil, then?" Cheney, who is widely perceived to be speaking for the oil industry, wouldn’t answer except to say that they should be stable.

In retrospect, these remarks foreshadow very bad times ahead — for consumers but not for the oil industry. The industry has not been able to gain new drilling rights, a decrease in taxes, or reduced regulations — all of which should be supported by any free marketeer — but the industry has obtained the next best thing: high prices for its product as well as boosted demand that comes with war.

Can you believe that prices have gone up four times in the Bush years? Between 1999 and 2003, the average household spent an additional 35% on petroleum products, an average of $500 per year more than previous years. This has dramatically boosted oil profits and spurred legislative moves for more investigations of price gouging (sheer nonsense) and a new oil tax (which can only harm consumers even more). The hysteria has only begun. The oil and gas industry may soon become the most hated in America, a victim of anti-capitalist hysteria.

So Cheney’s nightmare scenario of a price so low that no one will invest is not exactly an immediate threat. Not that this is a realistic scenario in the first place. Price declines should be a normal feature of a vibrant sector. Entrepreneurship leads to investment and production, and consumption, which leads to profitability and more entries into the industry. Competition drives the industry toward efficiency and innovation, along with price declines and ever more mass consumption. Computers and software are the best example of our times: a profitable industry deals magnificently with “deflation.”

So much for Cheney. What about Bush? His views are nicely summarized in the following anecdote told by David Frum, drawn from his experience as a policy adviser and speech writer.

I once made the mistake of suggesting to Bush that he use the phrase cheap energy to describe the aims of his energy policy. He gave me a sharp, squinting look, as if he were trying to decide whether I was the very stupidest person he had heard from all day or only one of the top five. Cheap energy, he answered, was how we had got into this mess. Every year from the early 1970s until the mid-1990s, American cars burned less and less oil per mile traveled. Then in about 1995 that progress stopped. Why? He answered his own question: Because of the gas-guzzling SUV. And what had made the SUV craze possible? This time I answer. “Um, cheap energy?” He nodded at me. Dismissed. (The Right Man, NY: Random House, 2003, p. 65)

Thus is Bush on the record as being for high prices and against low prices. I don’t pretend to have special insight on the menacing relationship between the very powerful US oil industry, the Bush administration, and the warfare machine that protects pipelines all over the Gulf region. There is every reason to dismiss claims that a conspiracy between industry and government can dictate a certain price. Prices are set on the free market, through the forces of supply and demand, and cannot be set by anyone in particular.

But conspiracies of producers and the government can have a huge impact on controlling the variables that go into affecting the forces that impact on prices. The Clean Air regulations of 1990 added vast new costs, for example, which puts upward pressure on prices. At the same time, emptying the boondoggle called the “Strategic Petroleum Reserve” throws more supply onto the market and reduces prices (all else remaining the same). This is what the Clinton administration did, not because it wanted lower prices but because it wanted to buy votes from consumers of heating oil.

Reversing this policy, the Bush administration has pumped up the SPR, most recently awarding massive new contracts to Chevron-Texaco, Shell Trading, and Vitol for the delivery of 93,000 barrels per day of crude beginning next month. This increases demand and diverts supply: a recipe for higher prices. The current goal of the Bush administration is to store 700 million barrels in the SPR, purchases undertaken at the highest nominal prices on record.

The Bush administration used to float the idea that Iraqi oil would somehow end up paying for the costs of the war. This whole scenario obscures the vast cost of government purchases of oil to conduct the war, a war which has already cost the average household $1,400 and will end up costing more than $3,000 per household. Is this a policy driven by a government working closely with industry? We would be naïve to think otherwise.

A final note: if anyone knows how much the Bush administration has spent on fuel to prosecute the Iraq War, please email me.

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