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The real reason why gas prices are increasing

By Rachel Alexander
web posted May 8, 2006

Gas prices are soaring again, and are expected to surpass last September's high of $3.07 a gallon after Hurricane Katrina. Yet this time, there is no Hurricane Katrina to provide an obvious reason why. Both Republicans and Democrats are blaming the oil companies. Bush and Congressional Democrats are calling for a repeal of tax breaks to oil companies. Politically, attacking the oil companies while gas prices are high is fairly safe, because many people already view them as faceless corporate entities that trash the environment while emptying their pocketbooks.

In reality, this criticism is shortsighted because the oil companies are not raising the cost of gas in order to earn higher profits. Punishing the oil companies will not fix the problem. In fact, it will cause additional problems, as ensued in the 1970's when the government set price controls on gas, resulting in long lines and shortages.

Nor will the problem be resolved by giving everyone a onetime $100 rebate, a short-term solution proposed by Congressional Republicans, or by temporarily repealing gas taxes, an equally shortsighted solution proposed by the Democrats. The Bush administration is contemplating a relaxation of clean-air rules in order to reduce the costs involved in producing gas. This would also be a temporary fix, since eventually environmentalists would force the regulations back into place. Instead of addressing the problem honestly, Bush and Congress are scrambling for a quick fix in order to ease voters' concerns about the cost of gas before the 2006 fall elections.

The reason gas prices are increasing is not the fault of the oil companies, but because of several factors outside of their control, most notably the cost of crude oil.

There are several costs that go into producing and delivering a gallon of gas. These include the cost of the crude oil to refiners, refining costs and profits, distribution and marketing costs, and federal and state taxes. Generally, the cost of the crude oil hovers close to 50 per cent of the cost of a gallon of gas, taxes comprise about 25 per cent, and the remaining costs average almost 30 per cent.

The current increase in gas prices is mainly due to an increase in the cost of crude oil, which has doubled over the past two years to more than $70 a barrel. This is the first of four underlying reasons why the cost of gas has increased. OPEC manipulates the price of crude oil. OPEC member countries hold about 2/3 of the world's crude oil reserves, and provide about 40 per cent of the world's crude oil. OPEC sets limits on the amount of crude oil its members may produce in order to keep the price of oil at a target level.

The cost of crude oil is also affected by conflict in oil-exporting countries, such as the Arab oil embargo of 1973. This most recent spike is caused by supply disruptions in the Gulf of Mexico and Nigeria. A correlating effect is caused by oil futures speculators who bid up the price of a barrel of oil whenever relations with oil-exporting countries sour, such as the current dispute with Iran over uranium enrichment and our increasingly poor relationship with Venezuela.

A second reason why gas prices have increased, which is the most important factor for the long-term, is that demand for oil has been gradually increasing around the world. Demand for new cars has risen in China and India. As those countries purchase more oil from OPEC countries, the U.S. is forced to turn to other oil-exporting countries at higher cost. Even if the U.S. chose not to buy any oil from OPEC countries, it would still be affected by OPEC's changes in price or supply, since the countries that continued to purchase from OPEC would be affected by those swings and so would purchase more oil from non-OPEC countries, raising the cost of oil sold by those countries to the U.S. During the first quarter this year new car sales grew by 4.8 percent in the U.S. People in the U.S. continue to buy SUVs, which consume more gas than regular cars, while living increasingly farther away from their work in suburbs outside of the ever-growing megacities.

Third, environmental policies in the U.S. have kept costs associated with production, refining, formulas, transportation and storage of oil high. U.S. crude oil production dropped as reserves ran out, and environmentalists have prohibited new drilling in Alaska's ANWAR. Because of the influence of Iowa farmers, many refineries are still in the process of switching from the additive MTBE to ethanol, at dubious value and excessive cost. Some areas of the country, like California, experience higher gas prices than the rest of the country due to even more stringent gas formula requirements, as well as their distance from the Gulf of Mexico pipelines. U.S. oil refineries are operating at maximum capacity, because liberals and environmentalists have prevented any additional refineries from being built for decades. Gas prices skyrocketed after Hurricane Katrina took out 10-15 per cent of oil refineries in the U.S. and interrupted pipelines from the Gulf of Mexico that fed the Midwest and the East Coast. Without additional refineries to take up the slack, any time there is a disruption affecting refineries, gas prices soar.

Finally, gas prices in the U.S. have not kept up with the cost of inflation. A McDonald's hamburger cost 28 cents in 1963, about the same price as a gallon of gas. That hamburger today (now called a double hamburger) costs about $3.00. Gas prices in European countries are twice as high as they are in the U.S.

What no one wants to admit is that gas prices are not meant to be as low as they have been. Any attempts to keep the price of gas down go counter to the free market law of supply and demand. Is that where we are at today, insisting on government controls simply to keep one particular commodity at a price we prefer? Even if we were to accede to socialist price controls for gas, permitting us to continue using gas at ever-escalating levels that exceed the laws of supply and demand, it will ensure that global oil reserves eventually run out.

The solution is to allow the market to determine the price of gas, which will force the auto and oil industries to look at alternative modes of energy as people find ways to use less gas. It is already happening. Columnist Thomas Brewton points out that ExxonMobil invested 68 per cent of its net income over the past five years into finding and developing new energy sources, even though its profits were far less than the media has hyped them up to be. ExxonMobil's profits compared to a company like Microsoft are miniscule; its net income to sales ratio peaked at 10 per cent last year, which is paltry compared to Microsoft's average of 25 per cent to 41 per cent ratio over the past decade. Punishing the oil companies will only take away marginal profits that they were using to invest in new energy sources.

So when you hear politicians criticizing oil companies and gas stations, remember it is because there is an election coming up.

Rachel Alexander is the founder of the wildly popular Intellectual Conservative.

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