Wednesday, April 13, 2011

Whom Should we Blame for High Gas Prices?

I found an article not so long ago on about the energy situation (specifically what we were facing in 2008). Wikipedia has an article about the general 2000s energy crisis, and in the introduction to the article mentions declining petroleum reserves, peak oil fanaticism, Middle East tension, and that harbinger of doom also known as the speculator. The article on the Mises website, instead of asking who to blame, instead asks the very simple question, "Are gas prices really all that high?"

The first thing mentioned that needs to be accounted for is a general rise in prices.

First, we need to take into account inflation. The result of the Federal Reserve printing too much money is a loss of purchasing power of the dollar: something that cost $1.00 in 1950 would cost about $8.78 today. As for gas prices, in 1950 the price of gas was approximately 30 cents per gallon. Adjusted for inflation, a gallon of gas today should cost right at $2.64, assuming taxes are the same.

Which of course makes perfect sense. When we compare income of people over time, we take into account inflation, so we therefore should do the same with gas prices. However, inflation does not answer all of the questions, as gas prices around this time were in the $3 range (that sounds good right about now, doesn't it?). Inflation, however, is not the only thing that would cause prices to change. Look also to the government.

But taxes have not stayed the same. The tax per gallon of gas in 1950 was roughly 1.5% of the price. Today, federal, state, and local taxes account for approximately 20% of gas's posted price. Taking inflation and the increase in taxes into account (assuming no change in supply or demand) the same gallon of gas that cost 30 cents in 1950 should today cost about $3.13.

Now we are getting much closer to the actual price, but as has already been alluded to, supply and demand have changed with time. We are not working with the same supply of oil that we had in the 1950s and we do not have the same amount of demand that we had in that time period. This, also, must be taken into account.

Neither have supply or demand remained constant. The world economy is growing. China and India are obvious examples. At the same time, Americans continue to love driving SUVs and trucks. As for supply, we are prohibited (whatever the reasons may be) from using many of the known oil reserves in our own country. Furthermore, due to government regulation, the last oil refinery built in the United States was completed in 1976. In addition, the Middle East is politically unstable which leads to a risk premium on the world's major source of oil. It is obvious that the demand for oil has grown while supplies have been restricted.

The average price of gas in the United States today is approximately $3.25. The question is, why are gas prices not higher than they are?

Although figures are not provided, the article implies that since this third contributor more than makes up for the $0.12 per gallon difference. In fact, the article claims that gas prices are much lower than they should be given the factors used. This is probably due to more competition and higher efficiency in drilling oil and delivering it, in which case we should be very happy about the state of oil prices. What we should be angry about instead is inflation, taxes, and regulations that strangle our discovery of new oil supplies.

So yes, in the end, while answering the question of whether prices are all that high, the author Sterling T. Terrell concludes that the price today is not due to the market, but rather government interventions into that market. But what about the oil companies and their huge profit margins? The article did not neglect this contention.

Blaming greedy oil companies on the rising price of gas is simply irresponsible. The profit margins of a few selected industries are as follows:

Periodical Publishing 24.9%
Shipping 18.8%
Application Software 22.5%
Tobacco 19%
Water Utilities 10.2%
Major Integrated Oil and Gas 9.5%
Hospitals 1.4%
Drugstores 2.8%

Oil companies do make a nice profit, but shipping, water utilities, and other companies by comparison make a killing. Why do we hear nothing about the profit margins of these companies? Why do we only hear the demonization of oil companies?

Next time you hear about rising oil prices (I'm sure you hear a lot about it nowadays, actually), remember to take a skeptical look at the opinions of pundits (I'm talking to you Mr. Windfall Bill O'Reilly). Make sure that they take into account inflation, taxes, and government regulations before they try to convince you that the market is to blame.


  1. Excellent job, Tony. I've bookmark your article for future reference.

    Tony, maybe you could answer some question for me. There have been numerous blog posts recently on the piss poor quality of our college students today. You are clearly not in that category. How is it on your campus? Are conservative/libertarian thinking students a small minority? Are most of the professors Liberals. I ask you because I've been out of the country for so long I just can't get a feel how things really are today. I would appreciate your insights.


  2. Thanks for the kudos, but I really have to give credit to the guy who originally wrote the article. I just wanted to popularize it a little.

    Now, my campus is full of many progressive-minded people, and I really think that it is because they have not been challenged by any other way of thinking. They think with their emotions, not with any kind of logic. UCLA is pretty bad when it comes to that, especially since the professors here are very liberal (though I must give credit to my science professors as they keep the lectures on-topic), especially the liberal arts professors. I have graduated and am now working as a TA (just last quarter), but the campus is the same as it ever was minus one libertarian.