Is Gasoline Cheaper Than Water? by Dom Armentano

Think gasoline prices are historically high? Think that there is no competition in the petroleum industry? Think that the oil companies earn a “monopoly”profit selling gasoline? Well think again.

When Ronald Regan took office in January of 1981, gasoline sold for approximately $1.40/gallon. Prices fluctuated up and down over the next 20 years but gasoline prices were still roughly $1.40 when George W. Bush was elected in 2000. After 2001, gasoline prices increased steadily and hit almost $4.20 in the summer of 2008; then prices fell back dramatically to around $1.75 in early 2009. Since then gasoline prices have risen to $4.00/gallon in April, 2012.

Is this pricing pattern over the last 30 years necessarily indicative of monopoly power, price gouging, or a total lack of competition in the oil industry? Hardly. Indeed, when we overlay gasoline prices with the price of crude oil over these very same years, there is almost a perfect fit. And since domestic oil refiners don’t control the international crude oil market, and since crude is the major (67%) cost component in gasoline refining, gasoline prices likely reflect the true costs (including the risk costs of supply interruptions) of producing and delivering refined product to consumers.

Federal and state taxes also play a role in gasoline pricing. When consumers purchase gasoline at the pump, they automatically pay a federal excise tax of 18.4 cents/gallon and an average state sales tax of 27.2 cents/gallon(far higher in California) for a grand total of 45.6 cents/gallon on average. Thus excise taxes alone account for almost 12% of gasoline prices at retail. On the other hand, the industry-wide gross profit margin for selling gasoline is 2.5% or roughly 10 cents/gallon while Exxon-Mobil, the largest domestic oil refiner, earns about 3 cents per gallon from all of its refined products sold in the U.S.

Critics charge that oil companies are “greedy”and “charge what the traffic will bear.” The fact remains that all market participants are greedy (consumers as well as sellers) and that all sellers, depending upon their competition, charge what the traffic will bear. Yet despite oil company self-interest (I would say because of it), the price of a gallon of gasoline is still roughly equal to the price of some bottled waters and, indeed, far cheaper than most premium brands like Evian ($7.49/gallon). Gee, I guess water companies must be greedier than oil companies.

Still another way of demonstrating that gasoline prices are not monopoly prices is to adjust gasoline prices for the general rate of inflation over time. After all, if gas prices simply reflect a decline in the value of the (dollar) currency, it would be wrong to conclude that prices are higher simply because of so-called monopoly.

When we adjust gasoline prices for inflation (in 1979 dollars), a gallon of gasoline cost roughly $1.20 in 1981, declined to 60 cents in 1999, rose to $1.40 in 2007 and is approximately $1.38 today. Thus in real price terms – that is nominal prices minus the rate of inflation – a gallon of gasoline that you bought yesterday at the local station is only marginally more expensive than it was when Ronald Regan became President. That’s monopoly power?

Critics would have you believe that the oil industry is not purely competitive because the bulk of the production is accomplished by 6 super major oil companies (even though there are 143 domestic oil companies). The first charge is bogus since pure competition is an intellectual fiction and exists in absolutely NO industrial situations. The second contention is true but irrelevant to an understanding of how large firms actually compete.

Oil companies, like all large industrial firms in legally open markets, engage in a vigorous competitive process where they must perform efficiently for stockholders and sell an improved product to willing buyers every day…else they lose market share to a rival. This process of rivalry is an explicit manifestation of Adam Smith’s “invisible hand”and is alive and well in oil refining. Critics that really want to understand monopoly power had best turn their attention from the phony issue of oil industry “concentration”to the real monopoly problem: the government-run OPEC cartel that nationalizes crude oil resources, controls crude oil production, and keeps costs high.

Consumers don’t like paying higher gasoline prices; we can certainly sympathize with that. But economic history teaches that the oil industry has always been workably competitive and that market prices tend to reflect market costs in the long run with a modest rate of return for suppliers. The problem, as usual, is government. The best that public policy can do is to remove legal or regulatory barriers that restrict production (fracking, drilling, pipeline and exploration delays) or abandon policies that artificially inflate industry costs including taxes and the risk-costs of new or expanded wars.

via Is Gasoline Cheaper Than Water? by Dom Armentano.

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2 Responses to Is Gasoline Cheaper Than Water? by Dom Armentano

  1. Pingback: What am I paying for in the price of a gallon of gasoline? [Minus Liberal Demonization] – John Malcolm

  2. Pingback: why is Greece in trouble? « power of language blog: partnering with reality by JR Fibonacci

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