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Reducing gas prices through American drilling

By Hunter Hines
web posted November 3, 2014

Like anyone who owns a car, I pay attention to the price of gas. Not only do American motorists run their cars on gasoline, the U.S. economy largely runs its transport on gasoline. As nearly all goods require transport, gasoline prices act as a supply shifter for nearly everything. As a result, increases in oil and gas prices can drop United States' GDP by billions of dollars. Unsurprisingly, given the pain of high gas prices to consumers and the importance of gas to the economy, the U.S. pays special attention to gas prices. Recently, low prices on oil have caused comparatively lower gas prices.

To both keep supply stable and reduce prices, some sources advocate a more open federal policy toward future oil drilling in the U.S. After all, basic supply and demand economics states that a change in supply due to more availability of the good causes prices to fall. Despite this general concept, a number of sources dispute this view. They argue that U.S. drilling would not have a significant enough impact on oil drilling in the world market to influence price. Administration officials have also called into doubt whether companies would increase drilling if the government did open more areas to leasing. Additionally, some sources argue that problems with oil refineries would stop an oil price reduction translating into a gas price reduction. However, more oil drilling in the United States would effectively reduce gas prices because the world market will not prevent oil price reductions, businesses would increase supply, and larger domestic oil supply would translate over to a greater gasoline supply.

Indeed, U.S. policies can and have influenced the world oil market. Far from participating in the market as a small country with only small oil production capabilities, the U.S. can impact prices as one of the world's top oil producers. Eventually, after the couple decades it would take for the oil to reach markets, greater oil supply would reduce oil prices, ceteris paribus. U.S. oil and imported oil also act as substitutes, meaning that more American oil would reduce U.S. demand for imports, which could lower prices or reduce future price increases. Nevertheless, it would not necessarily take decades for announcements of substantial future increases in drilling in the United States to reduce prices. Declaring a shift in American policy that would allow more oil drilling could change seller expectations. If speculators and sellers predict a fall in price, then they would put more oil on the market now to sell before prices fall and other countries would sell more oil, increasing the supply in the short run and reducing prices. This has happened before. After President George Bush repealed the executive moratorium on future offshore drilling in July of 2008, the price of crude oil quickly fell by over $9 per barrel, and following Speaker of the House Nancy Pelosi's announcement that Congress would allow its own moratorium to expire, prices dropped again. Accepting the view of a number of sources that attribute falling oil prices later in 2008 primarily to decreases in world demand would imply that this example suffers from a fallacy of false cause. Nevertheless, as prices fell abruptly after each of these policy announcements and then dropped more gradually, it seems logical that these announcements did at least partially cause each of the following drops. Recently, rising U.S. oil production has contributed to lower oil prices by increasing supply. Granted, other factors including lower demand in Europe have also facilitated this price drop, but this offers another instance of the U.S. influencing global supply. Analysis of U.S. participation in world oil markets and these examples demonstrate that the U.S. does have the ability to reduce oil prices.

Moreover, businesses would drill more in federal lands if the government permitted them to do so, thereby increasing supply. Facing calls to open more areas for oil and gas exploration, the Department of Interior (DOI) responded by urging oil corporations to develop current leases. As DOI categorizes 70% of offshore leases and 56% of onshore leases as inactive, administration officials imply companies do not want to expand and should develop existing territory rather than clamor for more. However, DOI uses a somewhat deceptive definition of "inactive." Their definition of active only includes leases currently producing or approved for development. Consequently, DOI labels both leases undergoing preparatory work, such as seismic surveying, and ones awaiting approval from other government agencies as "inactive." Logically, companies would also not pay for leases only to leave them idle. Shareholders would not allow oil corporations to simply continue paying for leases, unless the leases have some commercial potential. In addition some areas currently blocked off from drilling could also prove more commercially viable than areas open now. Meanwhile, the American Petroleum Institute, a trade association representing oil companies and related businesses, continues asking for more drilling. While the U.S. has entered a significant oil boom recently, the organization's CEO and spokesman, Jack Gerard, explains this expansion has occurred mostly on state and private lands and promises businesses could expand with more open federal policies. If the U.S. government heeded businesses calls to allow more drilling, businesses would expand the oil supply.

Finally, a greater oil supply would increase the supply of gasoline thereby reducing prices. As refineries make the critical conversion of crude oil to gasoline, they act as the link necessary for oil to run most of our transportation. Recently several U.S. refineries have closed. Sources opposed to more drilling have argued that refinery closures will prevent a positive change in supply of oil translating into an increase in gasoline supply. Admittedly, the elasticity of refinery capacity to lower oil prices is limited in the short run, although U.S. refineries do have about 2.4 million barrels per day in excess capacity. Lower oil prices would also benefit refineries by reducing costs of purchasing oil. It would take years for any oil the U.S. begins the process of extracting to reach refineries, and refineries could expand if they anticipate better business opportunities in the future. Furthermore, as domestic oil and imported oil act as substitutes, refineries that currently rely mostly on imported oil could switch over toward U.S. oil without needing greater capacity. While in 2011 the U.S. imported approximately 200 barrels of oil for every one it exported, the U.S. modestly exported more refined petroleum products than it imported. Since the U.S. imports oil and exports gasoline, U.S. refineries do have the capability to refine domestic oil. Thus, obstacles in the U.S. refining industry would not prevent an increase in the supply of oil from reducing gas prices.

As a result, allowing more drilling in the U.S. would meaningfully increase oil supply on the world market, give businesses the chance to increase oil supply, and translate over into a greater gasoline supply thereby reducing gas prices. America acts as a key player in global oil markets today and U.S. policy can influence prices. Freeing up access to its resources, the U.S. would give American corporations the chance to expand oil supplies. Generally, businesses can make better assessments on how their businesses should and will behave than federal agencies can. The Department of Interior has attempted to justify keeping reserves closed by implying that corporations have hoarded up leases and should not ask for more. In a market capitalist economy, the government should not prevent businesses from drilling on the basis that the government believes businesses do not want to drill. Last of all, refineries will help enable a greater oil supply to cross over to a greater gasoline supply. More broadly, energy prices are only one of several issues at play in discussions of whether to permit more oil drilling. In addition, greater domestic oil drilling would help create jobs, grow the economy, and reduce the trade deficit. On the flip side, drilling would come with real opportunity costs both to the environment and in some cases to other sectors of the economy such as fishing and tourism. In weighing the net benefits of drilling versus its opportunity costs, policymakers should consider a reduction in gas prices one of several advantages of greater drilling. ESR

Hunter Hines is a high school senior, living in the area surrounding Richmond, Virginia and takes take AP economics online. He also participates in team policy debate spending  the past three years debating U.S. policy from tax and revenue policies, to military presence and commitments, to marine resource policies. He plans to major in business finance. 




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