Gas Prices, Profits and a Silver Lining

At the Shell Station on Sherron Road in Durham, N.C., you would have paid $3.91 for a gallon of regular unleaded gasoline this week. Many in the Triangle are wondering: “How can oil companies justify record profits when I have to sell a kidney to fill up?” Somehow, they believe, that’s just not right.

But isn’t it? There is a silver lining to high gas prices. And there is a modicum of right in the profits they’re earning, too. Allow me to back up.

First, “record profits” is misleading every time it hits the paper. Consider the following industry profit margins, according to economist Sterling Terrell: “Periodical Publishing 24.9%; Shipping 18.8%; Application Software 22.5%; Tobacco 19%; Water Utilities 10.2%.”

Oil and gas profit margins are only 9.5%. So while the oil industry profits may achieve numerical records, their margins – compared with industries such as retail – are just average.  If oil companies are gouging folks, then publishers and shippers are pillaging them. And yet we never get Congressional investigations into Big Magazine or Big Shipping.

Indeed, maybe Congress and our state legislature should check the mirror: fuel taxes are, on average, double that of fuel profits (more in North Carolina, which enjoys the highest motor-fuels taxes in the Southeast, despite inferior roads.) Double.

Demagogues running for office are quick to leap on “record profits” headlines because they think they can tap into your consternation. But fuel prices are out of their control. Don’t be fooled when you hear some slick politician say he’s going to “do something” about Exxon-Mobil. Doing something a la Washington, D.C. means one of three things: price controls; “windfall” profits taxes; or subsidized biofuels. These are all bad options.

Price controls are an attempt to amend the law of supply and demand, which is a law in the same way gravity is a law—you can’t change it. If you charge people less for something they need, they’ll consume more of it. This causes shortages. It’s why you had long lines of angry people in the 1970s. Basic economics could have helped the country avoid deepening that crisis. But leave it to the politicians to ‘do something,’ which invariably makes things worse. If the U.S. was to impose price controls on gas, we’d be watching that 70’s show all over again.

Taxing oil profits is just as bad. Those billions of dollars the oil companies are making not only pad the retirement funds of teachers, firemen and other hard-working folks, they are the impetus for oil companies to go out and find more oil—maybe even oil that’s not under hostile sands. Profits attract investment.  But if there is less profit, there will be less investment. That means less capital for expensive oil platforms that travel 2000 ft. below the ocean’s surface. No platform? Higher gas prices.

Here’s some perspective: if you took away all the profits of the oil companies, it would only knock $.20 per gallon off the price. That’d still be $3.71 per gallon at that Sherron Road Citgo. But not for long, though. With no incentive to bear risk, explore, or increase refining capacity, demand would outstrip supply, as oil companies would’ve thrown up their hands. Why risk it if there is no money in it? For the social good? Seriously folks, profits keep gas in your car, not out. So don’t let demagogues fool you.

As far as biofuels are concerned, enough ink has been spilled in recent weeks about that corn-hogging, food-price spiking, environmentally ruinous, special-interest bonanza (which keeps cars running less efficiently and Iowa agribusinesses fat-n-happy on Caucus Day). So I’ll leave ethanol alone.
But cries for government action will get louder as gas prices rise and Election Day draws nigh — as if the President had some magical authority over the ups and downs of energy markets. An electorate largely ignorant of economics – inflation, speculation, demand in China, and foreign oil cartels – will happily exchange votes for promises of lower-priced gasoline. Sadly, the costs of such action will simply be spread to places we can’t easily see, but will feel anyway.

Ah—but here’s that silver lining: high prices make people ‘go green’ and innovators ‘see green.’

People like my dad may take their motorcycles to work because filling their pickups is too expensive. I just got a fuel-efficient Scion. Some will buy hybrids. Others will ride their bicycles to work or take the bus. But the price causes us to change our behavior in ways greens have been begging us to for years. (In fact, I find it curious that environmentalists are often the same people complaining about fuel prices and profits. They should be celebrating!)

Perhaps more importantly, however, prices send signals to entrepreneurs working on alternative energy sources and more efficient technologies. These signals work much better than government directives or subsidies. Just think about improvements in fuel economy and emissions achieved since the last energy crisis—due to competitive innovation, not efficiency standards (which, prior to this year, hadn’t been updated since the 1980s).

Due to current conditions, think of the lighter, stronger construction materials that will emerge later. Think of the improved motors. Think of the prospects for hydrogen power, or even oil taken from the Albertan tar sands. The possibilities are endless—endless due to prices, profits and human innovation.