The Oil Market Panic
The high price of oil is once again a front page story in The New York Times. Part one of its story asks why the prices are high now. Part two of that story asks what, if anything, should be done in response to those price increases. The short answer to the first question is that the increase in prices is due to contractions in the supply of oil driven by the instability in the Middle East. The short answer to the second question---which I take up in my weekly column for Defining Ideas---is that we should do nothing at all.
The greatest casualty of the current debate over the price of oil is to turn sensible market responses to its scarcity into grist for a political mill in an election year. The blame game between the political parties is likely to lead to flawed reform proposals that offer no short-term relief, but do impair the long-term efficiency of oil markets.
The “hands off” motto of laissez-faire capitalism has never been more pertinent than in this oil crisis. But both Democrats and Republicans are proposing policies that will meddle with the oil market. The imposition of any system of government subsidies or price controls will disrupt the market’s vital process of continuous adaptation; it will also cost a fortune to put into place.
Start with the Republicans, who are now salivating at the prospect of using the rising price of oil against President Obama. But just what does House Speaker John Boehner hope to accomplish when he tells his fellow Republicans to seize on the gas-pump anger, bemoaning the $4.00-plus prices at the pump? He can’t responsibly say that he wants these prices to be lower if they rose in response to scarcity. Nor can he lay the blame for the current dislocation at the foot of Obama, whatever else the president may have to answer for.
The only way in which to lower oil prices is to subsidize its consumption in some form, which is where Boehner’s thinking necessarily leads. Those subsidies have to come from somewhere, which means new or higher taxes. Another problem with subsidies is that they lead to the relative overproduction of the subsidized product and the relative underproduction of its close rivals. The president himself has called for greater subsidies for solar energy, whose entrepreneurs should be left to sink or swim on their own. Boehner is making the same mistake for oil. He needs to not panic in response to bad news.
Senator Rick Santorum must also tone down his rhetoric when he bashes the Democrats: “They want higher energy prices. They want to push their radical agenda on the public. We need a president who is on the side of affordable energy.” Not so. In this environment, higher prices are the best response to contracting supplies. There is, therefore, nothing radical in President Obama’s decision to stay on the sidelines on this matter. But there is a great deal of freighted meaning when Santorum mentions “affordable energy,” for it calls to mind a policy of state subsidies that distort relative prices across the board.
The political ignorance on the Republican side of the aisle is, alas, fully reciprocated by the unwise pronouncements that come from the Democratic side, as I explain in my over at Defining Ideas.
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May '10
Re: The Oil Market Panic
iWc: Add me to those who are simply astonished at Prof. Epstein's advice to do nothing.
Nuts.
We could open up drilling onshore and offshore. We could remove double taxation on oil revenues. We could pass a "cap" on federal taxation, so that the government (which does nothing to contribute to oil supplies) cannot make more profit per gallon of gas sold at the pump than the oil companies make (Right now Exxon makes 3-4 cents per gallon - the government profits by 48 cents per). We could reduce or remove all the crazy regulations that have kept any new refineries from coming on line for decades. We could build Keystone.
We are sitting on hundreds of years of petrochemical reserves. But the government won't let us get at it. There is PLENTY the government can do: GET OUT OF THE WAY. · 2 hours ago
Edited 2 hours ago
This exactly!
Mar '11
Re: The Oil Market Panic
R.E.: "In this environment, higher prices are the best response to contracting supplies"
Increasing supplies is the best response.
Sep '10
Re: The Oil Market Panic
jhimmi: More bi-fuel autos would lessen the impact of high oil prices.
As of 2010, Brazil had over 1.7 million CNG vehicles, the vast majority of which are also bi-fuel (CNG and gasoline), and the U.S had less than 150k.To get around the dearth of CNG fueling stations, there's actually a device that enables refueling at home, with a supply of natural gas.
Why doesn't the U.S. have millions of bi-fuel CNG vehicles? Is it because of iWc's Business Buffet Bear? · 2 hours ago
Because bio-fuels are less efficient and more expensive to create than petroleum, as simple as that. Let's please get out of the alternative energy subsidization business. Let the market find an alternative and in the meantime allow for the maximum amount of domestic drilling and refinement as possible.
Mar '11
Re: The Oil Market Panic
Prof. Epstein: I am partially with you.
Its important for some who have posted so far to remember that increasing domestic production today would not have a significant impact on the price of crude today. Issuing licenses today to drill in new places offshore (especially in deep water) or develop shale take years to come to fruition as the facilities must be constructed or moved and drilling and processing begin. It takes a number of years before those facilities begin functioning at any level, and because oil is a world-wide market it would take massive investments in this industry domestically to tip the scales. So, while there are a whole host of reasons to increase domestic production--increased energy security, reduced foreign policy entanglements, new domestic jobs and, eventually, a marginal positive effect on prices--none of these are going to reduce the cost of crude by the end of 2012.
The subsidies, distortions, and policies being put forward at the moment by both sides will have some of the negative effects Prof. Epstein mentions.
Aug '10
Re: The Oil Market Panic
knucklehead: R.E.: "In this environment, higher prices are the best response to contracting supplies"
Increasing supplies is the best response. · 36 minutes ago
Well, higher prices should induce more production, if more production is possible.
Unfortunately, a lot of production in the US has been ruled politically impossible.
Is it possible that what the good professor had in mind is that if oil prices aren't tinkered with, a substantial rise in price could provide the political impetus to permit the opening of our own reserves, for a change?
So I agree with everyone else. It's odd that this excerpt should not mention allowing the use of more of our own reserves as a legitimate government response to rising prices.
Aug '10
Re: The Oil Market Panic
Ronaldus Maximus
jhimmi: More bi-fuel autos would lessen the impact of high oil prices.
Why doesn't the U.S. have millions of bi-fuel CNG vehicles? Is it because of iWc's Business Buffet Bear? · 2 hours ago
Because bio-fuels are less efficient and more expensive to create than petroleum, as simple as that.
CNG is compressed natural gas, though. Which isn't a biofuel and is quite cheap.
Mar '11
Re: The Oil Market Panic
Crow's Nest: Prof. Epstein: I am partially with you.
Its important for some who have posted so far to remember that increasing domestic production today would not have a significant impact on the price of crude today.
Not so. The market reacts instantly to all kinds of "fuzzy" signals. For example, as we have seen, mere threats from Iran send prices higher.
The price of futures is an essential part of the oil market, and it would certainly lower oil prices TODAY if Obama believably announced all the initiatives I listed.
Mar '11
Re: The Oil Market Panic
Nevertheless, Prof. Epstein, here is where we part ways:
Now, while this is just fine as an abstract description of the way free markets function, it seems to imply that the oil market operates as a free market.
This is not the case. The oil market is massively distorted by OPEC, the Chinese National Oil Companies, Gazprom, the presence of many state run oil companies in the west (since you cited North Sea oil, consider Statoil) et alii.
Given this fact, a "hands off" approach would not necessarily result in better outcomes or less externalities, as you suggest.
So, I think the wrong answer is to "do nothing". I do think you are correct that the answer is not to offer more short-term subsidies, but there is every reason to reexamine our national energy policy, accept offers that come our way like Keystone, and increase domestic production soonest: a Republican approach.
Sep '10
Re: The Oil Market Panic
Crow's Nest:
The subsidies, distortions, and policies being put forward at the moment by both sides will have some of the negative effects Prof. Epstein mentions. · 16 minutes ago
Which Republican is calling for oil subsidy?
Mar '11
Re: The Oil Market Panic
Mark: Republicans subsidize a whole number of industries, but they do it differently than Democrats do. Our side tends to do it through the tax code. Currently, oil companies are provided a number of loopholes that both sides have historically supported. But, as one example this year, Newt Gingrich has recently proposed that the oil companies that he will issue licenses to drill (great!) will be allowed to write off 100% of the cost of new equipment (granted, this applies to any "manufacturing" interest). But this functions essentially like a subsidy by another name for "manufacturing".
iWc: I largely agree with your points, and your statement in #15 that
I don't disregard the role of futures, but "market distortions by governments" are likely to respond to any announcement by the United States that we are intending to dramatically increase domestic supply.
Sep '10
Re: The Oil Market Panic
I think Professor Epstein thoroughly beat down the strawman of Republican market intervention. Bravo ;)
jhimmi: More bi-fuel autos would lessen the impact of high oil prices.
Why doesn't the U.S. have millions of bi-fuel CNG vehicles? · 4 hours ago
As an automotive tinkerer, I would be very interested in converting one of my vehicles to bi-fuel capability.
Does that make me "bi-curious?"
Sep '10
Re: The Oil Market Panic
The status quo is not ideal. Lower rates (how about zero for all corporations?) and fewer exemptions/credits would be better. Still, I don't believe citing historical support for a muddled corporate tax code is enough grounds to make the claim that Republicans, here and now, are calling for additional tax credits to Big Oil. Except..
This is not a policy I would favor, but then Newt is a subsidy pusher in the extreme. He even wants to continue green energy subsidies.
Rick Santorum has specifically called for an end to energy subsidy. Maybe Professor Epstein is weary of this promise, but he should at least acknowledge it.
Mar '11
Re: The Oil Market Panic
We let companies write off investment. Why should we single oil companies out by NOT letting them write that off as well?
It is not a "subsidy" to let people keep money that they have earned. It is a subsidy when taxpayers PAY money to companies. There is a world of difference!
It is the same distinction as that between paying less tax, and receiving government unemployment checks. Liberals think they are the same thing. We know better.
May '10
Re: The Oil Market Panic
iWc: We let companies write off investment. Why should we single oil companies out by NOT letting them write that off as well?
· 51 minutes ago
I think too many people get caught up in how large of a number their revenue is. Too few of them bother to look at what the profit margin is though.
Sep '10
Re: The Oil Market Panic
Are you saying the current tax code has a special provision that prevents oil companies from writing off equipment, and that Newt is merely attempting to level the playing field? My impression was that Newt was introducing additional provisions for oil companies, above and beyond the current tax code.
Mar '11
Re: The Oil Market Panic
iWc: Letting an individual keep more of his income is not the same thing as allowing a corporation to write off 100% of its investments. Moreover, while we encourage investment through the tax code, this adds to tax code complexity and tends to favor big business over small business (those who can hire a room of lawyers to negotiate the legal meaning of "investment" and "manufacturing" stand to gain more than the guy who can't). Presently, we allow some business to write off some aspects of investment, not every last dollar of it.
Secondly, from a moral standpoint it makes a big difference if you allow a business or a person a tax break verses supplying them with a federal tax-payer paid for subsidy. There we agree. But from a purely economic standpoint, the two have nearly indistinguishable effects.
Finally, I'm happy to rephrase my point as follows if you are: Let's get the government out of the habit of providing subsidies or tax loopholes to businesses, simplify the tax code, lower the corporate tax level to a competitive level and grant licenses to exploit domestic energy resources (higher profits than subsidies or tax-breaks follow).
Mar '11
Re: The Oil Market Panic
Crow's Nest:
Finally, I'm happy to rephrase my point as follows if you are: Let's get the government out of the habit of providing subsidies or tax loopholes to businesses, simplify the tax code, lower the corporate tax level to a competitive level and grant licenses to exploit domestic energy resources (higher profits than subsidies or tax-breaks follow). · 1 hour ago
I am happy to do all of the above. But I think the licenses should be simple "use it or lose it" mineral leases, with no royalties due. After all, the government gets paid through corporate tax (and a vast host of other downstream taxes), and we recognize that increasing supply is a Good.
And then to make it fun, every "use it or lose it" lease should come with a default "Approved" status on exploration, drilling and transport plans unless a specific objection is raised by the respective government regulator within 30 days of plan submission. That is a fast track!
Mar '11
Re: The Oil Market Panic
Mark Belling Fan
Are you saying the current tax code has a special provision that prevents oil companies from writing off equipment.
A provision allowing them to write off investment is the "Big Oil Subsidy" the liberals attack.
Edited on February 21, 2012 at 11:45pmMay '10
Re: The Oil Market Panic
A further confounding factor: the public feels the pain in the form of gasoline prices, not directly from oil barrel prices. But I have read from several sources that the US is a net exporter of gasoline -- we bring oil in, refine it into gas here, and then sell it to foreign countries in the world oil market. So there is a sense in which increasing our own production will have less impact on the "pain at the pump" than we might expect simply because we will continue to compete on the world market for the refined gasoline. But eliminating alternative energy subsidies and eliminating artificial obstacles to production are both policies on which Obama is very vulnerable. They should be exploited to the fullest extent.