Why are Gas Prices so High?

Hearing people complain about the price of gasoline has become commonplace. In fact, I bet you can't get through an entire workweek without someone making a snide remark about the rising price at the pump. If present trends continue, talking about the price of gasoline may eclipse talking about the weather as the de facto office platitude.

There are a few things my grandfather is known for. He likes seafood, has an affinity for high-quality vodka, and he loves loves loves to bitch about gas prices. Driving with my grandfather is always an interesting experience for many reasons, not the least of which is his taking constant vocal inventory of gas prices in the small towns we pass through. To understand what I'm saying, try to imagine grocery shopping with your mother, only instead of passively checking items off her list as she drops them in the cart, she instead announces the price of every product in every aisle as you make your way through the store.

Now, the point of this article is not to make fun of my family. I love em' to death...that's why I make fun of them. But yesterday when I heard my one millionth complaint about the price of gas, I decided to consider the price of gasoline from an economic perspective. So what's all the complaining about, anyway?

Several reasons are offered as explanations for the high price of fuel, and the range from the conspiratorial (easily the most enjoyable to read) to the angry (those greedy capitalists are at it again!) As with most difficult issues the truth probably lies somewhere in between, with a slight dash of conspiracy...because what's life without a little conspiracy thrown in?

Perhaps the most prevalent--and accepted--explanation for the increased price of gasoline is the "price gouging" or "excessive profit seeking" theory. You are most likely to hear this argument on radio talk shows and television programs from a democratic perspective. The problem, they say, is the oil companies collude in order to fix prices at a high level in order to extract from the consumer every last available penny. Every subsidiary company involved with some form of oil, from drilling to refining, is involved in the conspiracy, they charge. I file this explanation under the "angry" heading.

But are they right? I don't think so. They are correct when they suggest that oil companies exist in order to seek the highest possible profit, but doesn't every business exist for the same reason? Find me a CEO who's content 'just scraping by' and I'll show you someone who will soon be out of business. In order to survive in our quasi-free market, a businessman is forced to find the cheapest, most efficient means of producing a product for the most amount of people, thereby increasing his profits. In other words, reaping huge profits is another way of saying that the businessman has a successful product, and a lot of people are satisfied with that product or they would cease purchasing that product.

Furthermore, if a business wants to raise prices, so what? If Shell wants to charge $5 a gallon, what's the problem? A business should be free to charge whatever price they wish for a particular product, and will inevitably suffer the consequences--good or bad--of their pricing scheme. Higher prices mean less consumers will be able to afford your product. In other words, by raising prices to $5/gallon, Shell is effectively "pricing out" certain segments of the population. Fewer people buying Shell gasoline means less profit for Shell. Therefore, the "price gouging" explanation doesn't hold water.

But wait, Eddie--what if every oil company raises its prices to $5 a gallon via some secret meeting? Ahhhh, now we're venturing in to conspiracy territory, my friend, and it gives me great pleasure to address this question. Actually, this explanation has more truth to it than conspiracy. The fact is there are very few oil companies, lending credence to the idea that such a secret meeting is possible. Organizations such as OPEC do meet regularly to determine the price of gasoline, but I'll explain how cartels such as OPEC are unable to completely dominate the world oil market for prolonged periods of time.

Let's take the argument to the extreme, then. Let's say that every oil company in existence meets in some smoky room and decides to raise the price of gasoline to $10/gallon. Is this possible? Sure, I suppose. But as any member of the mafia will tell you, the more people you have involved on the "inside," the more likely you are to have your secret exposed. In this case, I'm not talking about exposure in the traditional sense. What good would knowledge of a secret meeting do for the public? Not much. Rather, I'm referring to the temptation for one member of the cartel to undersell his competitors without them knowing about it. This could be accomplished via the black market (another consequence of "price gouging" by the way) or through overt military force. The temptation to undersell would be HUGE, and protecting your ability to undersell would be easy, especially if you have the guns to do so.

Also, as stated above, if the price becomes too steep for consumers, less people will buy the product, thereby decreasing profits for the cartel.

Another fallacy is that gasoline prices are rising because of shortages in supply. While it is true that oil cartels such as OPEC can manipulate prices in the short term, no oil company (or cartel) has a large enough market share to sustain long-term withholding of supply from the market. My first question when confronted with this theory is, what good does unsold oil do for the cartel that is "hoarding" it? Critics often point toward the price spikes in the 70's that crippled the American economy, courtesy of OPEC. I cannot address every residual issue surrounding the price shocks of the 70's (mostly because I'm no expert on the era), but suffice it to say the government played a significant role in maintaining oil shortages across the country.

Today the "shortages in supply" theory is plain laughable. The fact is gasoline is available on demand at practically every busy street corner, 24 hours a day, 7 days per week, without shortages. Can you name a gas station that recently closed due to insufficient supply? I think not.

So we're back at square one: why are gas prices so high? We've dispelled the angry explanation and we've worked our way through the conspiracy/half-true argument. I subscribe to the theory that recent surge in gasoline prices can be tied directly to a combination of two things: our irresponsible monetary policies and our government's refusal to allow the free market to work.

The inverse relationship between gas prices and the strength of the dollar is no coincidence. The Federal Reserve injects "liquidity" (i.e. prints more dollars for use) into world markets with hopes of resurrecting our weak economy, and so far it has not helped. The result is always the same whenever more money is injected into the economy when not accompanied by corresponding increases in capital: increased prices. The issue goes back to supply and demand. When more dollars are chasing the same amount (or fewer) goods in an economy, the result is a rise in prices. Markets are simply responding to the rapid increase in the amount of money circulating in the world market. As the world's "reserve" currency, the dollar is directly involved in this scheme. For me, the blame can be laid squarely at the foot of Ben Bernanke.

Finally, I would be remiss if I didn't address some of the domestic roadblocks that prohibit us from increasing our own supply of oil and therefore lowering prices. Tapping in to our existing resources, such as the strategic reserve, drilling in ANWR and at various other off-shore locations, would go far in decreasing the price we pay at the pump. And let's not forget the excessive (and ridiculous) taxes levied by federal and state governments on the sale of a gallon of gasoline. Taxes alone account for nearly 50 cents per gallon sold--50 cents! Regardless of your opinion on offshore drilling and/or ANWR exploration, the evidence suggests that the government itself plays a significant role in the high price of gasoline.

It has been years since I've ridden in an automobile alongside my grandfather, but I'd accept the invitation in an instant. Only this time I'd (hopefully) be able to explain to him the reasons for rising gas prices...and thus alleviate any frustration the man may still have. Sure, I can't decrease the amount of money he will pay at the pump, but there's peace in understanding, right? The way I see it, we'd both be at peace--him knowing the root cause of gas price increases...and me not having to deal with audible price lists!