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Energy Price Idiocy

This column was written by Jonathan H. Adler.

Congressional leaders are rushing to "do something" about near-record gasoline prices and the looming threat of further price spikes this summer. With little political support for another pork-laden energy bill like that already signed into law by President Bush, House Republican leaders plan a series of votes on a wide range of energy-policy measures. Unfortunately, many of the ideas on the table, including new energy-conservation mandates and measures to combat "windfall profits," could do more harm than good.

A case in point is the bipartisan stampede against "price gouging." Despite the lack of evidence oil companies or anyone else is manipulating gasoline prices, this month the House voted 389-34 to criminalize "price gouging." The House did not bother to define the crime, delegating that job to the Federal Trade Commission. Nonetheless, a vast majority of congressmen were sure service-station owners should face jail time and fines up to $2 million if they charged "too much" for gas. This is sheer lunacy.

Criminalizing "price gouging" will do more to encourage gas shortages than control price increases. Whether politicians like to admit it or not, the profit motive plays a key role in calibrating supply and demand. Limit the ability of companies to profit from energy-related investments and they will make fewer of them. Limiting the potential for profit will limit future supply. Threaten companies with prosecution should they respond to market conditions by raising prices, and shortages are the inevitable result. During the debate, House Energy and Commerce Committee chairman Joe Barton said, "Price spikes are a scourge, but dry pumps are a catastrophe." Barton and his colleagues supported a proposal that will make "dry pumps" more likely nonetheless.

If their aim is to keep gas prices under control, Congress should make it easier for profit seekers to match supply to demand, not criminalize profit-seeking. Insofar as anything on Capitol Hill can lower gas prices — and Congress' power is limited in this regard — the answer is not more government regulatory intervention, but less.

Consider the shortfall in domestic refining capacity. While gasoline prices are largely a function of global crude markets, the lack or surplus-refining capacity makes temporary price spikes more likely because refiners are unable to respond to regional changes in demand. Some of the gap between domestic demand and domestic-refining capacity can be made up through imports, but here the United States is at a disadvantage due to our more stringent environmental requirements for domestic fuels.

Regulatory impediments, combined with traditionally thin profit margins, have combined to discourage capacity-increasing investments. The lion's share of recent investment in the refining sector has gone to meet various environmental and other regulatory mandates, rather than increasing output. Siting and permitting new facilities is particularly difficult. If it took the Arizona Clean Fuels project a reported five years to obtain air-quality permits for a proposed refinery project, few companies will be encouraged to follow their lead.

Last year, Sen. Inhofe proposed modest legislation to streamline permitting requirements for refineries. Such a modest step could reduce the cost and uncertainty involved with environmental compliance without sacrificing environmental protection. Yet like other modest and sensible policy proposals, the bill fell victim to political posturing. A similar measure was proposed in the House, but it is far more heavy-handed than necessary to do the job. Ideally, Congress would not only streamline the permit process but also authorize the EPA to waive applicable environmental requirements where there are more cost-effective means to meet the same environmental goals.

Another source of gas-price volatility is the balkanization of gasoline markets by the proliferation of gasoline-formula requirements. Under the Clean Air Act, different parts of the country now require the use of various "boutique fuel" blends at various times of the year. By segmenting national gasoline markets, these requirements have made some regions more vulnerable to supply disruptions and price spikes. In the past, if a pipeline went down or refinery closed for repairs, the resulting regional shortfall could be met by gasoline from virtually anywhere else in the country. No longer, as different places require different types of fuels. The Bush administration recently authorized the suspension of such rules under certain conditions, but Congress needs to act as well to prevent the adoption of additional boutique fuel requirements and, over time, reduce the variety of fuels required today.

Energy Secretary Samuel Bodman proposed another worthwhile measure: eliminating tariffs on ethanol imports. If Congress is going to insist on passing ethanol mandates — a political addiction without apparent cure — it should not force consumers to pay for ethanol at inflated prices — over 50 cents more per gallon of ethanol. Most ethanol sold in the United States is made from corn, which is not a particularly cost-effective feedstock for the alcohol-based fuel. This is one reason ethanol-content requirements tend to increase the price of gas. Other countries, such as Brazil, make ethanol far more cheaply from corn. If Congress wants to reduce oil consumption by substituting ethanol, allowing ethanol imports would reduce the cost of this policy at the pump.

It would also be helpful if political leaders would acknowledge that most changes in prices are due to factors well beyond their control. The global demand for energy is on the rise, and will continue to increase, regardless of what Congress does. India and China are not about to curb their appetites for carbon-based fuels.

On the bright side, the importance of energy to U.S. economic growth is on the wane. Gasoline prices may be near-record highs, but the affordability of gasoline — measured as a function of income — has increased significantly over the past 25 years. Equally important, the energy intensity of the U.S. economy is dropping, as American companies learn how to squeeze greater output out of each unit of energy. Thus the economic repercussions of increased prices are less severe.

Markets respond naturally to price fluctuations when they are able to do so. Higher prices signal to investors that there are potential profit-making opportunities. Where markets are free to operate, price increases should spur investments to increase supply (and should encourage consumers to reduce consumption). Government interventions in commodity markets, whether direct or indirect, tend to short-circuit the market's natural feedback mechanisms. This is as true of regulations that balkanize gasoline markets as it is of ill-conceived efforts to combat "price gouging." Myriad government policies already retard energy markets' ability to respond to changes in supply and demand, and thereby increase price volatility and likelihood of temporary supply disruptions. If Congress is unwilling or unable to improve on this situation, the last thing it should do is anything to make it worse.

Jonathan H. Adler is contributing Editor and associate professor and associate director of the Center for Business Law and Regulation at the Case Western Reserve University School of Law.

By Jonathan H. Adler
Reprinted with permission from National Review Online

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