TCS Daily


Big Oil's New Conspiracy

By Pejman Yousefzadeh - September 8, 2006 12:00 AM

We have heard much in recent months about the plot by oil companies to gouge consumers at the pump. Now, I am writing to report another insidious plot on the part of Big Oil. They are scheming to lower prices.

Shocking, I know. But it is all true. Just read:

"Gasoline prices are falling fast and could keep dropping for months.

"The only place they have to go is down," says Fred Rozell, gasoline analyst at the Oil Price Information Service (OPIS). "We'll be closer to $2 than $3 come Thanksgiving."

Travel organization AAA foresees prices 10 cents a gallon lower by the end of next week. It reported a nationwide average of $2.84 Tuesday, the lowest since April 20.

It's good news for consumers and the economy. Continued lower prices "may act like a tax cut" and stimulate spending, says Richard DeKaser, chief economist at National City in Cleveland. He calculates that higher energy prices the first six months cut growth of consumer spending 1 percentage point.

The U.S. average for a gallon of regular peaked this year at $3.036 Aug. 10, according to OPIS/AAA daily surveys. That's slightly under the high of $3.057 Sept. 5, a week after Hurricane Katrina battered petroleum production in the Gulf of Mexico and caused fears of fuel shortages."

The conspiracy of which I write is a vast one. It even involves oil companies manipulating countries and international crises the way a grandmaster would manipulate pieces on a chessboard:

"Oil fell more than a dollar to less than $68 a barrel on Monday, pulled lower by expectations that any sanctions against oil producer Iran were some way off and would not necessarily disrupt export flows.

U.S. light sweet crude was down $1.17 to $68.02 a barrel, just off a session low of $67.77.

London Brent crude settled at $67.71, $1.44 a barrel below Friday's close. Its session low was $67.59, the lowest level since June 21.

Trading volumes were light as the New York Mercantile Exchange pit was closed on Monday to mark the Labor Day holiday. U.S. futures were only trading electronically and the ICE exchange, where Brent trades, closed early."

Okay, so I am being facetious.

Needless to say (you'd think), the arguments alleging oil company manipulation of the market value for gasoline are fundamentally flawed. According to these arguments, oil companies have the power in the first place casually to adjust the market value of gasoline with the same degree of impunity that you and I have in determining what we want to have for lunch. Of course, even those who are minimally knowledgeable about economics know that the primary influence on the market value of gasoline is the law of supply and demand. As the USA Today report linked above suggests, the end of summer means reduced driving needs which in turn reduce the demand for gasoline. The report also points out that gasoline use in the first eight months of this year is up by less than the amount considered typical. This reduced demand helps push down prices.

Additionally, supply is increased because "federal requirements for clean air, summer-blend gasoline end next month, making gasoline cheaper to refine and import." The Reuters story linked above reports a further reduction of demand fears with speculators and observers betting that there will not be any political conflicts with Iran in the near term that will reduce supply.

All of these facts notwithstanding, we will continue to be plagued by myths that gas prices are somehow capriciously and artificially set by businesspeople bound and determined to rob consumers of their hard-earned dollars so these self-same capitalists can line their filthy pockets. But the merest bit of Googling brings up excellent rejoinders demolishing these myths.

Economist Don Boudreaux points out, for example, that to the extent that sellers capriciously "choose" to sell gas at a certain price, buyers also "choose" to buy it at that price. Additionally, Professor Boudreaux reinforces the fact that market value for gasoline is set (again) by supply and demand, not by individual people at all:

"When hurricane Katrina destroyed much oil- and gasoline-producing capacity in the gulf south, the supply of gasoline fell. This sudden fall in supply made the market value of each gallon of gasoline rise. No one -- no flesh-and-blood person -- no oil-company executive, no bureaucrat, no consumer, no one -- chose for this rise in market value to happen.

Prices, of course, typically adjust to reflect market values. (Or perhaps we should say instead, "prices typically are adjusted to reflect market values.") Because the economist recognizes that prices serve their purpose best when they accurately reflect market values -- and because the economist recognizes also that the incentives in private-property markets generally lead participants in those markets to set prices in accordance with market values -- when the economist says "supply and demand determine prices," what he or she means is that underlying supply and demand conditions determine market values and that the incentives confronted by sellers and consumers prompt each to agree to exchange each product at a price that reflects its market value.

So while prices can be kept above or below the market values of the products in question, market values are not subject to such manipulation.

The economist understands that prices are best that reflect market values; the non-economist too often overlooks this fact."

The end result, as Professor Boudreaux writes, is that calls for gasoline companies to charge at rates below market values really constitute calls for market failure. In the end, this does more damage to the interests of the individual consumer and the economy as a whole than any supposed greedy and capricious "price gouging" on the part of a gasoline supplier or the oil companies.

It is also worth pointing out that at no point during the recent increase in gas prices did the increase reach crisis levels. On the contrary. As this post points out, when adjusted for inflation in terms of 1979 dollars, gas prices are not even close to the level they were a little over a generation ago. And with gas prices now poised to fall dramatically as supply outstrips (anticipated) demand, the fears of "crisis" should diminish further still.

All of this goes to show that the explanations behind increases and decreases in gas prices are more complicated than conspiracy theorists about market manipulation by oil companies and gas station merchants would have you believe. To be sure, none of what I write will stop the myths from spreading. Next summer, when prices inevitably go up as demand increases, there will be claims of "price gouging" along with demands that the Federal Trade Commission (FTC) investigate whether "gouging" has occurred. In fact, a price increase -- along with demands for an FTC investigation -- could occur as soon as the next significant natural disaster. That trend has been well-established, after all -- as have FTC findings that debunk price-gouging claims (and explain price increases by "regional or local market trends"). When it comes to explaining the variance in gas prices, lots of people prefer to mythologize rather than face up to the cold, hard facts of economics.

Pejman Yousefzadeh is a TCS Daily contributing writer.

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