Falling Pump Prices Prove the Market Works After All
By Ben Lieberman
Few vacationers paying $3 per gallon on their way to the beach last Labor Day could have imagined gas prices dropping 80 cents by the time they headed out to Grandma's for Thanksgiving. But it has happened, and if trends continue, the national average could dip below $2 per gallon before Christmas.
While most politicians are still obsessed with the price run-up immediately after Hurricane Katrina, there are far more important lessons to be learned from the subsequent decline.
Katrina hit the Gulf Coast on Aug. 29, and the resulting combination of reduced oil production, knocked-out refineries and closed pipelines sent gasoline prices skyrocketing nearly 50 cents per gallon in a week. At its worst on Sept. 5, the national average hit $3.06 per gallon.
But by week two, prices dipped below $3 as oil companies began fixing damaged energy infrastructure and overseas gasoline shipments started arriving. And, with the exception of a smaller spike caused a few weeks later by Hurricane Rita, the price at the pump has been falling ever since.
The lesson is that markets work. Katrina-induced supply shortfalls caused an immediate jump in prices, which quickly triggered a series of self-correcting actions. The additional profit motive sent the oil industry scrambling to make repairs even before the floodwaters had receded, bringing supplies back online very quickly. Similarly, the high prices attracted extra gasoline from Europe and elsewhere to the American market.
In addition to encouraging more supplies, the price rise also induced the public to cut back on unnecessary driving, temporarily bringing down demand.
Thanks to this market response, the pain at the pump didn't last long.
The price decline also should help dispel the post-Katrina theories about Big Oil manipulating prices. After all, if the oil companies could create $3 gas whenever they wanted, why would they do so for only a week? And why would they allow declines averaging a cent per day for the past 10 weeks? The steadily plummeting prices after the hurricane season should put such speculation to rest.
Too many in Congress still complain about Labor Day gas prices and ignore the subsequent decline and reasons behind it. Several bills seek to impose price controls and windfall profits taxes, which experience shows would do more harm than good.
Price controls were tried in the 1970s, and they were an unmitigated disaster. By trying to push prices down below market levels, these federal controls discouraged the forces that lead to increased supply and decreased demand. Thus, rather than a brief price spike being quickly alleviated, price controls served only to prolong the agony. We saw numerous gas shortages lasting for months at a stretch during the 1970s, and we would see them again if price controls were brought back.
Similarly, the windfall profits tax, designed to confiscate oil-company profits in a time of high prices, actually would discourage producers from bringing badly needed fuel to market during a crisis. Few oil companies would go to the difficult and costly lengths to rush supplies to a market that sorely needs it if the government would take most of the profits for doing so.
In other words, Washington's favorite solutions wouldn't have helped had they been in place after Katrina. Quite the contrary, they likely would have derailed the price decline.
Nonetheless, there are things Congress should do. Markets work, but only to the extent they are not hampered by federal laws and regulations. Thus, the government should consider streamlining the many burdensome regulations that make it difficult to expand oil-refining capacity. Congress should allow access to domestic energy supplies that are currently off-limits, including the estimated 10 billion barrels of oil in Alaska's Arctic National Wildlife Refuge.
But other than that, Washington should give thanks for the remarkable and ongoing drop in the price at the pump — and avoid doing anything that would get in its way.
Lieberman is a senior policy analyst at the Heritage Foundation, a Washington-based public policy research institute.
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