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Wieffering: Rising gas prices not as evil as you might think

  • Article by: ERIC WIEFFERING
  • Star Tribune
  • March 24, 2012 - 10:26 PM

Americans believe deeply in the virtues of free markets. Except when they behave in ways we don't like.

Few events better crystallize this double standard than our reaction to the rising cost of gasoline.

Last week, the average price for a gallon of gas in the Twin Cities was $3.72. That's almost 30 cents higher than a month ago, and more than double the price in late 2008. Nationally, the average price is about $3.85, and in some parts of the country it's closer to $5 a gallon than $4.

There are simple, logical reasons for the price increases. There's even an argument to be made that higher oil prices are, in the long run, a good thing. But presidential candidates, some elected officials and policymakers are fixated on the notion that higher prices are inherently evil and can be fixed, which means we risk making policy decisions that, though politically popular, could do long-term damage to the economy or energy policy.

As always, Public Enemy No. 1 during periods of rising gas prices is usually the oil companies themselves. It's almost a law of nature: When oil prices go up, congressional investigations of price gouging are launched.

Most of these efforts go nowhere because price gouging is a difficult concept to prove, and it rarely occurs on the scale that is imagined or alleged.

There's no question oil company revenues surge when oil prices go up. But oil companies have huge fixed costs, so only a fraction of those higher prices trickle down to the bottom line.

Exxon Mobil's 2011 sales rose by almost $100 billion from 2010, but the company added only $10 billion in profit. Most of the remaining $90 billion was spent getting oil out of the ground and to the world's factories and consumers.

Even in good times, oil company profit margins pale next to those of other industries. In 2011, with oil prices near all-time highs, Exxon cleared a profit of about $88 on every $1,000 in sales. Compare that to Apple Inc., which banked $280 in profit for every $1,000 in sales.

OK, so if not the oil companies, then there must be something that we can do about those nameless, faceless speculators and hedge funds who make large and generally short-term bets on price movements in oil, wheat, corn and other commodities.

Like it or not, commodities are part of the global financial system, which in addition to the secretive hedge fund manager includes the mutual fund where you have parked your retirement account. For every study that attempts to prove that investors are driving up prices, there are two or more that suggest they're simply, as one author noted, "hitchhikers along for the ride."

Still, longtime oil speculators like Delta Air Lines don't like having to compete with a crowd of short-term-oriented investors, and they're just one of several companies backing a measure in the Dodd-Frank financial reform act that would place strict limits on some speculative investments in certain commodities.

This is one of the most controversial aspects of Dodd-Frank -- and for good reason. There's no clear indication that the restrictions are necessary, and no proof that they would work, either.

It didn't work in 1958, when onion growers lobbied Congress to make onions the only commodity with no futures trading. The result: Onion prices became more volatile than ever, rising and falling even more sharply than oil between 2006 and 2008.

Recently, some economists at the St. Louis Fed tried to figure out how much of a role speculation played in rising fuel prices between 2000 and 2009. They settled on an estimate of 15 percent, and that finding got a lot of headlines. But lost amid the noise was their conclusion that demand accounted for 40 percent of the price rise during that period.

And that's what's at work now. The economy is growing around the world and, as usual, growing even faster in China, India, Latin America and other developing nations. This means not only higher demand for oil and gasoline to power factories, equipment and vehicles, but for the petroleum-based products needed by those factories to make everything from plastic for car parts to fertilizer for farmers.

Nobody likes to pay $4 a gallon at the pump, but in measuring the cost to our pocketbook, we usually fail to account for the benefits of high oil prices.

Higher profits for oil companies mean they're more likely to invest in new wells and expand their refining capacity, which could ultimately lead to more stable or perhaps even lower prices. High gasoline prices lead to the production of more fuel-efficient cars and trucks, and the rapid advancement in battery technology. High oil prices also encourage more rapid adoption of solar, wind and other alternative energy sources, which both lessens our reliance on imported oil and is better for the environment.

The supply of oil, as we all know, is not unlimited. If more people suddenly want it, the price will go up.

Not because the system was rigged, but because it worked.

ericw@startribune.com • 612-673-1736

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