Ten Don’ts for Our Government on Gas Prices

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As gas prices in the United States continue to soar, policymakers in Washington are eager to point fingers and offer solutions. Most of the ideas are not new, and some are certainly much better than others, but they will inevitably be part of the debate. As legislators turn their attention to gas prices, here’s a straightforward list of what not to do.

1. Don’t increase subsidies for biofuels. The most popular subsidized biofuel, ethanol, produces less energy per unit volume than does gasoline, contributes to food price increases, costs taxpayers billions of dollars, and has dubious environmental effects. Despite the promise that cellulosic ethanol would be available by now in mass quantities, it’s not. A more prudent approach would be to remove the subsidies and mandates for domestically produced ethanol and remove the tariffs on imported ethanol.

2. Don’t drag on drilling permits. As the only country in the world that places a majority of its territorial waters off-limits to oil and gas exploration, at the very least we should be drilling in the areas where we do have access. Removing the de facto moratorium on drilling would immediately increase supply, create jobs, and bring in royalty revenue to federal and state governments.

3. Don’t subsidize electric cars. Taxpayers have doled out billions for advanced battery vehicle development manufacturing, and they subsidize every electric vehicle purchase (from $2,500 to $7,500, depending on the battery capacity). Even so, the demand for electric vehicles is low because electric cars are prohibitively costly even with the handouts—as evidence by low electric vehicle sales. Consumer Reports director David Champion remarked that the Chevy Volt and Nissan Leaf were not the panacea everyone hoped for, and Consumer Reports issued quite a critical review of the Volt.

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4. Don’t promote wind, solar, or nuclear as oil alternatives. Democrats and Republicans alike are guilty of claiming that we can end our dependence on foreign oil by increasing wind, solar, and nuclear production. Increasing production of these sources of energy would affect electricity production, not transportation fuels. We use very little oil to produce electricity.

5. Don’t release the Strategic Petroleum Reserve (SPR). Neither the intent for establishing the SPR nor the President’s authority to tap it suggests that the release of stocks is appropriate for the current situation. A mere rise in price is not what the reserve was intended to deal with. Releasing SPR would have very little impact on prices at the gas station.

6. Don’t implement price controls. Price controls were tried before by the federal government in the 1970s, and the consequences were disastrous. The experience showed that attempts to force gasoline prices below market levels invariably result in shortages. Price controls mean that resources do not go to their most efficient use. Another clear example is generators after a hurricane. When Katrina caused massive power outages, the demand for generators rose, and, consequently, prices did as well. Governors implemented price ceilings, and instead of allocating generators efficiently to where they would be valued most (gas stations and grocery stores), they went to employees of Home Depot, their families, and their friends.

7. Don’t blame speculators. Speculators, at best, marginally increase the price of gasoline if it leads to oil inventories increasing—but only in the short run, because businesses have to unload these inventories. Many fear that this can create a speculative bubble, but as my colleague David Kreutzer points out, speculators can actually help consumers: “If, after a period of simultaneously rising prices and inventories, the inventories are reduced and the price holds steady or rises, then there was no speculative bubble after all. This pattern would instead be confirmation that futures markets anticipated higher prices but didn’t cause higher prices. That is, in aggregate, traders on the futures markets correctly anticipated deteriorating supply and demand conditions, saved petroleum for the worse times, and provided additional barrels when they were most needed.” This is exactly what we saw in 2008. Speculators can also drive prices down in the short run. The reality is that blaming speculators is a costly diversion to real solutions.

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8. Don’t implement a windfall-profits tax. Criticizing big oil companies and their big profits is very popular, but it won’t help consumers by taxing them. The windfall-profits tax (WPT) is an excise tax on oil when its price exceeds some predetermined level. One Member of Congress introduced legislation in 2005 that would have imposed a 50 percent tax on the price of oil above $40 per barrel. There is a considerable populist appeal to taking more in taxes from big oil at a time when they can most easily afford it and giving the proceeds to taxpayers when they are straining to pay high energy costs. But the last time the WPT was tried, it backfired badly. It discouraged expansion of domestic energy supplies and led to increased oil imports.

9. Don’t fear monger about peak oil. Three decades ago, proven world oil reserves were 645 billion barrels; five years ago, it was 1.28 trillion, and in 2009, it was 1.34 trillion. New, innovative technologies and sound policies to allow access will help to recover that oil and discover more. Yes, oil is a finite resource, but the market will do a much better job determining how and when we transition away from fossil fuels.

10. Don’t block access to our resources. At least 19 billion barrels of easily recoverable oil lie off the currently restricted Pacific and Atlantic coasts and the eastern Gulf of Mexico. Another 19 billion barrels estimated to be in the Chukchi Sea off the Alaskan coast are inaccessible because of onerous regulations, such as acquiring air-quality permits. Another obvious and senseless restriction is in the Arctic National Wildlife Refuge, where an estimated 10 billion barrels of oil lie beneath a few thousand acres that can be accessed with minimal environmental impact. While it would take time to get this oil from the ground and the pump, we should set the policies in place to allow companies to explore and extract if a commercial interest exists.

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