Thursday, May 29, 2008

Gasoline prices: the latest case for more limited government

[Congress] has made it impossible for U.S. producers of crude oil to tap significant domestic reserves of oil and gas, and it has foreclosed economically viable alternative sources of energy in favor of unfeasible alternatives such as wind and solar. In addition, Congress has slapped substantial taxes on gasoline. Indeed, as oil industry executives reiterated in their appearance before the Senate Judiciary Committee on May 21, 15% of the cost of gasoline at the pump goes for taxes, while only 4% represents oil company profits.

If Congress really cared about the economic well-being of American citizens, it would stop fulminating against IOCs and reverse current policies that discourage, indeed prohibit, the production of domestic oil and natural gas. Even the announcement that Congress was opening the way for domestic production would lead to downward pressure on oil prices.

There is an historical precedent for such a step: Ronald Reagan's deregulation of domestic crude oil prices at the beginning of his first term. At the time, thanks to the decision by the Organization of Petroleum Exporting Countries (OPEC) to curtail output, the price of oil was at a level that in real terms is only now being matched. Domestic price controls ensured that the OPEC cartel would face little or no competition in the production of oil.

Price controls were exacerbated by other wrongheaded policies stimulated by the two "energy crises" of the 1970s. One of the most egregious was the infamous "windfall profits" tax, designed to punish oil companies for alleged profiteering. But since it applied to even newly discovered oil, its main impact was to discourage the exploration and drilling that would have increased oil supplies.

Although the energy problems of the 1970s were traceable to government policies, Reagan's decision to deregulate oil prices was ridiculed by policy makers, especially those who had served in the previous administration. For instance, Frank Zarb, who had been Jimmy Carter's "energy czar," predicted that decontrolling the price of crude oil would lead to gasoline prices of $10 a gallon. Instead, the world price of oil plummeted, helping to fuel the extraordinary economic growth of the 1980s.

Reagan's deregulation of crude oil prices created incentives for domestic producers to invest in exploration and to increase production. The threat of increased output by non-OPEC producers destroyed the discipline among OPEC members necessary to restrict production to maintain high prices. Facing the likelihood that an increase in supply would lead to lower future prices, OPEC producers increased output in the hopes of maximizing profits before prices fell. The cascading effect caused oil prices to tumble.

As in the 1970s, U.S. energy policies have essentially restricted the exploitation of domestic sources of energy. Curtailed supplies have combined with rapid, world-wide energy demand to increase the price of oil and other sources of energy. This provides leverage to foreign producers and threatens U.S. energy security. Freeing up domestic energy resources will do today what President Reagan's decision to deregulate oil prices in 1981 did then: cause oil prices to fall, thereby enhancing U.S. energy security.

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