DOING MY HOMEWORK. Here is the preparation I made for Wednesday night's testimony at the House Republican Task Force on Motor Fuel Prices. I've arranged the points in the order I made them during the hearing, moving the sources of price increases first to refer to some work the Task Force's research staff had presented as an introduction to the hearings.

1. Why the higher gasoline prices? Three reasons, one temporary and two permanent. The temporary reason first. Domestic production and domestic refining have been disrupted by several hurricanes. As the damage is repaired and the workforces return, those sellers will compete for buyers. However, the transition from summer to winter blends of gasoline, which is subject to safeguards against commingling blends in the same storage tanks, leads to localized clearance sales of the blend going out of season and spot shortages of the blend coming on season. This is a permanent feature of prices under the current rules. The real permanent reason, however, is the economic growth elsewhere, with India and China in particular increasing their fuel use of all kinds, as well as replacing coal and wood with petroleum products.
   
   That demand is likely only to increase. At some world price for crude oil, the temptation to develop resources in Alaska, off the Florida coast, and possibly in the Great Lakes may be sufficiently great that policy makers will conclude we can no longer afford to preserve those areas in their current state.
   
   Note that I haven't mentioned two popular explanations. Some people have blamed environmental regulations that impede the construction of new refineries. That argument is special pleading. U.S. refinery capacity and production have both been increasing steadily since 1982, shortly after the end of the crude oil price controls in place during the Nixon, Ford, and Carter administrations as well as the severe recession early in the Reagan administration. There is a chart available from the BP Statistical Review of World Energy from June 2005 and some commentary by James D. Hamilton, an economist at the University of California, San Diego, at his web journal. Another economist, Steve Verdon, in his web journal, notes some evidence of oil companies using the environmental regulations to thwart their competitors' construction of refineries, which the Foundation for Taxpayer and Consumer Rights has been following closely. Such behavior doesn't surprise me. It reminds me of the way trucking companies would use the Interstate Commerce Commission to impede competition. “The existing service is adequate. If additional service is required, the existing carriers are ready to provide it. The applicant is incompetent to provide the service.”
   
   Others have pointed to rising concentration in oil refining. Although at the time of Exxon's merger with Mobil, I made a joke to a class about naming the company “Standard Oil Trust of New Jersey” and having done with it, the reality is an oil business that is far from a monopoly. The Federal Trade Commission and the Justice Department approved that merger, as well as the BP-Amoco merger and several other mergers, with divestitures of some gasoline stations and tank farms. The top five oil refiners account for 44 percent of refining capacity in 2002 (.pdf). The domestic oil business probably qualifies as a “moderately concentrated” market according to the Justice Department's current merger guidelines. Hotels and motels and public accounting appear to be tighter oligopolies than refining. The Federal Trade Commission has a longer report of testimony by General Counsel William Kovacic before the U.S. House, detailing Commission investigation of anticompetitive behavior by refiners and gasoline distributors.
   



2. General Principles. Resources are scarce and they have competing uses. There aren't enough to satisfy everybody. Economists favor the use of prices to allocate resources because that's the least bad option. A higher price gives buyers an incentive to conserve and sellers an incentive to expand output. A higher price also raises the reward to development and commercialization of substitutes. A price control takes away both of those incentives. Consumers will attempt to buy more of the good than they would at higher prices, and producers will offer less for sale. The result is what economists call “excess demand” at the price, or more succinctly, a shortage. In the case of gasoline, the visible symptom of excess demand is a gas line.
   
   I quote my colleague Tim Schilling of the Chicago Fed.

   Prices are important. They give us information to make decisions—to make choices. And prices can make us uncomfortable. They tell us how the rest of the world values the products and services available to us…what others are willing to offer…and then ask us to evaluate our choices in light of that information. They ask us, "how badly do you want this?" "What are you willing to give up?"

   Governments have considered other methods of rationing goods. In the case of gasoline, years ago some states used an odd-even buying plan in which the last digit of a license plate controlled whether a person could gas up that day. People can simply shift their purchases to the days they can legally buy, but they might buy more at that price than they otherwise would for fear that in two days the supplies will be exhausted or the price will be higher. Or they can steal somebody else's license plates. Another possibility is for the government to issue ration coupons limiting how much gasoline a person can buy at the controlled price. Because an underground economy in ration coupons developed during World War II, modern versions envision allowing people to freely trade their ration coupons. In so doing, the government increases the wealth of people who sell off some of their ration coupons. The total price a buyer of a ration coupon pays for gas, however, will be higher than the competitive market price, as buyers of ration coupons will be competing for some part of the smaller supply of gas being offered at the lower controlled price.



3. Interfuel substitutions. I mentioned in my opening remarks that a higher price for gasoline and other crude oil products is an incentive for inventors to develop substitutes. In this vein some recent research at the Weizmann Institute, to use the heat of the sun to release hydrogen from zinc oxides is promising. In Illinois, our neighbors grow corn that can be used as an input into ethanol for extending or replacing gasoline. The economics of this technology are a bit challenging. An Argonne National Laboratory report (.pdf), finds environmental benefits from using corn as a source of ethanol as well as a positive “net fossil energy” value (less fossil energy used in cooking the ethanol than replaced by the ethanol based fuel.) A longer Argonne report (.pdf) notes improvements in the technology by which the ethanol is obtained from corn.
   
   Some of the claims the industry itself makes do call for further scrutiny. (See the American Coalition for Ethanol's “Net Energy Balance of Ethanol Production" (.pdf).) On the one hand, the document correctly notes that the cost of the fertilizer, pesticides, fertilizer runoff, or tractor fuel will be incurred whether an ear of corn is grown for ethanol or for feed. It errs in suggesting that the ear of corn will be grown in any event. A proper accounting of the environmental costs of a larger corn crop faces a tricky problem identifying how much of that work would not be done but for the demand for an ethanol feedstock. On the other hand, the document comes close to charging the entire cost of military operations in the Persian Gulf to keeping the sea lanes open. Some of those resources might have been deployed to deal with another product of that region, jihadis. Some of those resources might have been deployed even if the region did not produce oil, as a consequence of the United States being on the winning side in World War I, ending the Ottoman Empire's control of the area, and in World War II, where disarming Japan leaves the United States with the responsibility of keeping Japan's sea lanes open. Alternatives to fossil fuels might have their value, but taxpayers ought not be swayed by special pleading, whether from the ethanol coalition or petroleum interests.
   
   I have no special expertise in evaluating the use of home-grown bio-fuels as a way of defunding oil producing countries. That's more properly the purview of specialists in international relations.

My actual testimony addressed the high spots of this research, with some extemporizations to refer to material in the research service's presentation and observations made by people who testified ahead of me.