The Giant Gas-Gouging Gaffe

By Robert P. Murphy

On Wednesday the House passed a bill that would make price gouging by oil and gas companies a federal crime. The legislation called for jail time and fines of up to $150 million a day for charging "unconscionably excessive prices" and taking "unfair advantage" of consumers.

As frequent readers of this website already know, this proposed legislation is horrendous and would do nothing to help the American motorist. In this short piece I'll outline some of the major problems.

VAGUE LANGUAGE

The most obvious difficulty is the arbitrariness of the "crime." Say what you will about outright price controls, at least they're explicit. In contrast, how's the owner of a gasoline station supposed to know if he's charging "unconscionably excessive" prices? After all, if he's taken a basic economics course, he might think that any market-determined price is quite reasonable. If this bill becomes law, sellers here will be at the mercy of the FTC the way drivers are at the mercy of traffic cops — you can always get written up for something.

While we're at it, let's just spend a moment on the wording of this bill. Why isn't it a crime to merely charge "somewhat excessive" prices — though perhaps not receiving the same penalty as unconscionably excessive ones? (After all, it's a crime to murder someone, but it's also a crime to punch someone in the face.) Come to think of it, shouldn't we also punish unconscionably low prices — after all, they're unconscionable by definition! And if you can't imagine what that would mean, maybe an unconscionably low price is one where mom and pop gasoline stations can't stay in business. (You know, kind of like unconscionably cheap imports from China that we have to keep out for reasons of "fair trade.")

And let's not forget the other clause, taking "unfair advantage" of the consumer. Shouldn't it also be a crime to take "fair advantage" of the consumer? (After all, you're still taking advantage of the consumer in this case.)

My point, of course, it that this language refers not to objective behavior, but merely reflects arbitrary subjective judgments on the part of the government official meting out the punishments. Adding on a layer of uncertainty and vague threats of massive fines and possibly jail time won't increase the supply of gasoline, and hence won't help motorists.

WHY ARE PRICES SO HIGH?

Before using the guns of the federal government to try to force them down, people ought to first consider why it is that gasoline prices are so high. The usual explanation — "The oil companies are greedy and want to screw over the hapless drivers!" — makes no sense. After all, oil companies were greedy during the whole 1980s, when the price of a barrel collapsed to under $11 (in nominal terms) in July 1986. And automobiles weren't invented in the last three years, so it's not as if the US "addiction" is something new.

The general causes for high oil prices are pretty straightforward: Supply is restricted because of the mess in the Middle East (not to mention environmental and other regulations), while demand is booming as China and other developing countries grow much more quickly than people had anticipated years ago (when oil infrastructure decisions were made). On top of these "real" factors, the general uncertainty about the Middle East — especially the possibility of war with Iran — has caused speculators to push up the price even higher.

Now high oil prices explain gasoline prices in part; if oranges are really expensive, you can bet that orange juice won't be cheap. But what is particularly strange is that oil prices are actually a lot lower than they were just last July ($64 and change as of this writing, compared to highs of $78 in July), yet prices at the pump are at all time (inflation-adjusted) highs.

The immediate answer is that refineries can't keep up. (If there were a major strike at Tropicana packaging plants, then the price of orange juice would be higher still, than would be justified by higher orange prices.) There are all sorts of reasons people have given, such as the lingering effects of Katrina, new environmental regulations about diesel fuel, restrictions on new refinery construction, and so on.

PRICE CAPS CAUSE SHORTAGES

But regardless of the specifics, the thing to remember is that market prices are not arbitrary. The market price is the one that (tends to) equate quantity demanded with quantity supplied. If a gas station can charge "whatever the market will bear" at $3.15 per gallon, but only charges $2.85 out of fear of fines, then it automatically follows that this gas station will have to sell people fewer gallons than they want to buy at the lower price. In other words, the proposed legislation will cause dreaded shortages of gasoline.

The only thing I've "assumed" to reach this conclusion is that people buy more gasoline at lower prices. If you grant me that, then you have to admit that government efforts to reduce prices below their market levels will cause shortages, and that means (as in the 1970s when the great Republican Nixon imposed price controls) long lines at the pump and arbitrary rationing schemes.

This is an important point so let's make sure we follow it: The market price is the one that matches supply with demand; it's the one where gas stations want to sell the same amount of gallons that motorists want to buy. So if the government forces the gas stations to lower this price, then motorists want to buy more gallons than they would have at the higher price. So unless you think a gas station owner would be willing to sell certain stockpiles of gas for (say) $2.50, but he wouldn't want to sell them at (say) $3.15, you have to admit that this legislation will lead to lines at the pump.

Incidentally, this isn't academic speculation. This is exactly what happened during the hurricane season, when people in the Gulf states tried to flee to safety. Certain gas stations (out of fear of punishment or perhaps misguided altruism) didn't raise their prices, even though their business was astronomical (since everyone was headed for the highways). The result? These gas stations got drained fairly quickly, and consequently many of the fleeing motorists ran out of gas and were stranded on the interstates.

TAKE IT TO THE LOGICAL EXTREME

I'll wrap up this article with a simple question: If all it takes is a stroke of the pen for Congress to magically lower gas prices back to "conscionable" levels, why not go further? Why not make it a crime to charge "moderate" prices too, so that we're left with very cheap gasoline? Woo hoo, break out the SUVs!

Once you think through the logic of why a government-imposed cap of (say) 25 cents per gallon wouldn't work, it's not much harder to see why a cap of $3 would be bad too.

The reason for high prices is increased scarcity. The way to solve that is to make it worthwhile for producers to increase supplies. No one in his right mind would spend billions looking for new oil fields, laying pipelines, hiring geologists, etc. if it looks like Congress might tax "windfall profits," impose price controls, or artificially stimulate demand for a competitor's products.

The oil industry involves long time horizons, and investors don't want to be exposed to a fickle public. Property rights serve a purpose, after all.

The solution to high oil and gas prices is to get the government out of the way. Ease restrictions on new refineries and oil drilling, get rid of taxes on gasoline, and stop threatening to nuke Iran. That would solve the "crisis" very quickly.