Honolulu Advertiser

SECOND OPINION  by Cliff Slater

September 12, 2005

Keep the government’s hands off oil

Because of Katrina we are in for some difficult times in the months ahead in the energy field no matter whether it is in the form of gasoline, oil, natural gas, or electricity.

If the federal government, or the various states, bow to public pressure to take hold of the pricing and distribution of energy, it will only make matters much worse.

The core of the problem is that we now have a highly disrupted processing and delivery system in the Gulf of Mexico and onshore in Louisiana and its adjoining states.

The Gulf accounts for one third of U.S. crude oil production[1] and Katrina has shut down 90 percent of it.[2] In addition, natural gas representing 15 percent of total U.S. consumption is cut off.

The release of oil from the Strategic Oil Reserve will ameliorate the shortage somewhat. However, Katrina wiped out enough of the nation’s refining capacity to reduce by 10 percent the amount of gasoline we normally process and use. And the nation’s gasoline inventories were already at very low levels.

This capacity was already very tight to begin with since there have been no new refineries built in the U.S. since 1975.

All of which tells us that there are going to be significant price fluctuations and distribution problems until the industry settle down to this new, but assumedly temporary situation.

But first, class, an economics lesson on “shortages.”

Barring short-term catastrophes, of which Katrina is a perfect example, shortages do not occur in free market systems. If we have shortages, it is because the demand exceeds the supply and that only occurs when prices are lower than market, a situation normally caused by government price capping.

Otherwise, when suppliers even sense that future demand is likely to exceed supply, they raise prices to dampen demand — and maximize profits. In turn, these higher prices stimulate suppliers to increase supply by using methods that were formerly uneconomic.

Thus the dampened demand and the increase in supply leads to a new balance between the two.

Some believe that it was shortages of oil and gasoline that caused the long lines and distribution problems of the 1970s.

However, the primary cause of the gas lines was the allocation program and gasoline price controls required by the 1973 Emergency Petroleum Allocation Act. The energy czar of the time supervising the federal program, William E. Simon,[3] later said that,

“The normal distribution system is so complex, yet so smooth that no government mechanism could simulate it. All we were actually doing was damaging the existent distribution system. The kindest thing I can say about the allocation process is that it was a disaster.”[4]

He added that other elements of the program not only increased "Disincentives for crude oil exploration and production,"[5] but it also meant "The economy was shielded from price hikes, stimulating domestic demand."[6]

The cumbersome allocation process, together with price controls, which had already held down domestic production, led to spot shortages throughout the country. Lines formed at gas stations and every day people waited in line for hours in one place although in neighboring counties gasoline might be plentiful.[7] Frustrated and frightened, consumers believed that we were 'running out of oil' and that all the warnings of the Club of Rome and others were coming true.

We learned our lesson back in the 1970s let us hope that our nation’s leaders have more sense than our Hawaii elected officials and leave price caps alone.

Earlier this year the official U.S. forecast for 2006 oil prices was $30 a barrel. There is no long-term rationale for $70 a barrel, as there is no rationale for long-term gasoline prices at their present level.

All we have to do is let the market get beyond the present near panic, let the repair work begin and wait for matters to work themselves out.

Cliff Slater is a regular columnist whose footnoted columns are at: www.lava.net/cslater


[3] later became Secretary of the Treasury

[4]Simon, William E. A Time for Truth. McGraw-Hill. 1978. p. 53.

[5]THE U.S. PETROLEUM INDUSTRY, PAST AS PROLOGUE 1970-1992. DOE/EIA-0572. Energy Information Administration, Washington, DC. September 1993.

[6]Simon, William E. A Time for Truth. McGraw-Hill. 1978. p. 53.

[7]Simon, William E. A Time for Truth. McGraw-Hill. 1978. p. 53.