TCS Daily

The O'Reilly X-Factor

By Duane D. Freese - October 7, 2005 12:00 AM

Higher energy prices lately have prompted lots of colorful but deeply flawed commentary. Consider Bill O'Reilly of Fox News' "O'Reilly Factor" who recently targeted the five major oil companies for alleged price gouging:

        "Tuesday's Factor included an extensive discussion about the pricing of 
        gasoline and the huge profits American oil companies are making. One thing 
        struck me -- after all the experts we've talked to, all the research we've done, 
        we still can't find out who sets the price of a gallon of gasoline. Somebody tells
        your local gas station owner exactly what to charge, but the five major oil 
        companies manage to fog up the situation so much that confusion reigns. Eight 
        governors have now asked President Bush to investigate alleged price gouging.
        They base their assertions on a study done by economist Don Nichols, who
        says for gasoline to cost $3 a gallon, the barrel price that OPEC charges would
        have to be $95. Since OPEC is presently charging $58, Professor Nichols concludes
        the US oil companies have some explaining to do. All Americans should cut 
        back energy consumption and not buy gas on Sundays. Let's send a message 
        to these energy people who operate in the shadows. The government 
        owes us some oversight, but we owe it to ourselves to use less oil. Let's do it."

Further, he wanted them to cut their profits by 25 percent, in one broadcast, and 20 percent in another. "The big contribution would be if the oil companies would give up 20 percent of their profits. They'd still make a gazillion dollars," he opined.

What O'Reilly is really claiming is that the "oil industry" is fixing prices. You can't gouge unless you can fix an uncompetitive price. And you can't set an uncompetitive price without colluding to fix the prices. And collusion is a violation of the antitrust laws.

That's what we have the Federal Trade Commission and Justice Department for, and the FTC is already investigating the issue. It's getting a million bucks from an amendment to an appropriation bill to investigate potential gas-price gouging at all levels of the supply chain.

History, as the Washington Examiner editorialized, shows that the likely result of the investigation will be that the oil industry is competitive, that there was no price fixing and that, yes, they tried to maximize profit -- but that's what companies do in a competitive market. Doing otherwise would put them out of business.

Which brings us to O'Reilly's suggestion that they cut their profits by 20 percent. What that would require is that they, well, collude. Otherwise the one firm cutting its profit 20 percent would quickly go out of business.

Think about it. Who owns oil companies? It isn't just the John D. Rockefellers or oil sheiks anymore. It's also investors with money in mutual funds and pension funds and retired people. Consider that CalPers, the giant public employee retirement system, had such a presence in energy giant Shell last year that it pressured the company for an independent audit of reserves.

So, when O'Reilly asks the companies to cut their profits, unless they act in unison, one company would see all those investors jump ship. Just the hint that a company was not out to maximize profits could lead its investors to shun its stocks.

O'Reilly also puts too much credence in a study by a University of Wisconsin economist who said that it would take $95 a barrel gasoline prices to justify the current price at the pump. The economist's analysis missed a key point -- that the oil industry's costs are not static. To give just one small but significant example, hurricanes in the Gulf of Mexico have taken a toll that will require them to spend more in the future.

But more important, it simply overlooks basic economics -- that prices are not set by past costs but by supply and demand. It is through prices that businesses can figure how to most efficiently allocate resources.

As Paul Cwik of the Ludwig Von Mises Institute wrote back in 2000 during another period of complaint about "gouging":

"Prices are little packets of information, signals if you will, to entrepreneurs. They tell the entrepreneur how to adjust resources in their production process so they can act in the most efficient manner possible (meaning: production with the least amount of waste). Prices are formed by everyone making decisions (based on their own subjective preferences) to buy or not to buy. A shortage can only be caused be an incorrect price. If the market is allowed to transmit the correct signal (read: equilibrium price), then the quantity supplied exactly equals the quantity demanded."

Without that signal, though, supplies become misallocated very quickly. Back in the 1970s, federal officials monkeyed with the price mechanism through price controls. If you were around in the 1970s, you remember the images of gas lines and stations without any gas at all.

As for profits, they signal investors whether to put more into an industry so as to increase supplies. Daniel Yergin of Cambridge Energy Research Associates and author of a major history of the oil industry, "The Prize," noted in a column in the Washington Post in July that investments drawn in by the higher oil prices of 2001-2003 (higher when compared to the 1990s) would increase oil production capacity by 20 percent by 2010.

And if Congress can get some of the regulatory hurdles out of the way, refinery capacity in the United States can increase so as to avoid the kind of supply disruption hurricane Katrina caused, allowing the new supply of oil to moderate price spikes.

If Bill O'Reilly and government officials itching for price controls and tax increases get their way, repeating the mistakes of the 1970s, we'll get no more investment in energy production, and that will guarantee one thing -- higher prices for energy in the future.


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