Forget gas prices - It's the cost that counts

Republicans can chant “drill, baby, drill” all they want, but they can’t repeal the basic laws of economics. More drilling won’t lead to lower gas prices, and it’s important to understand why: simply put, growing the supply of oil will do little to lower prices so long as oil markets are global and demand keeps growing.

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Nonetheless, it’s not hard to understand why gasoline prices are a hot button issue for both consumers and politicians. There is perhaps no greater visible “price” in our economy. For example, you don’t see the price of “white” “wheat” and “multi-grain” bread on three different 50-foot illuminated signs at a typical suburban intersection; nor do you see signs for the price of milk, eggs or other popular basic commodities.

Thus, the political debate over gas prices is entirely out of whack—focusing on price when it’s cost that really matters.

I run a small business, serve on several boards of directors and manage a family budget. At the end of every month, the entry for “fuel” in my budget, like most people, does not say “$4 per gallon.” Instead it cites a number that is the product of price and the amount consumed—the cost. Therefore when businesses and families complain about gas prices, what they really are reacting to gas costs.

This essential point sounds so obvious as to be hardly worth the ink. Yet, if you tune into the debate in Washington, you quickly see why it is important. Political affiliations aside, failing to distinguish between price and cost when debating energy and environmental policy is simply dangerous.

The power plant that can produce the lowest priced electricity, for instance, is likely an old coal plant that has been fully amortized and has minimal environmental controls. A new solar plant will therefore have a tough time competing solely on price. But the compared costs are an entirely different matter, especially once you have factored in the health problems and other negative effects from sulfur, soot, ozone and mercury emissions into the price of the coal-produced power. These often forgotten side-effects are what economists call “externalities”.

But, that the debate about gasoline’s price versus cost is even simpler. If gas is $4 per gallon and John the plumber’s truck gets 15 miles per gallon and his business requires him to drive 1000 miles a month, his business has a top-line hit of about $3,200 per year. By contrast, if Bob the carpenter’s truck gets 30 miles per gallon and he also needs to drive 1000 miles per month, the top-line hit to him is about $1,600 per year. So what does this show?

Basically, that the abstract price of gas is irrelevant. John’s $4 gas feels like $2 gas to Bob, since the latter is getting more “bang for the buck” through improved mileage.

Decades of political debate, though, have focused almost solely on what the government can and should be doing to lower the price at the pump. However, such objectives entirely miss the point.

Unfortunately, it seems the one form of government “activism” that everyone, including the hardiest Tea Partier, can believe in is controlling gas prices.

The problem is that such policies almost never succeed. Oil is a global commodity whose price is largely determined by low cost producers, who control the largest reserves. These producers tend to be members of an oligopoly that has undue market influence over supply—and prices. This is why increasing domestic oil production might have some benefits, creating jobs for example, but lowering prices is historically not one of them.

And, of course, we should be looking seriously at alternatives to gasoline—electricity, natural gas and other fuel sources. Our feeble ability to impact prices suggests that our policy focus should be on efficiency and the equivalently powerful variable in the cost equation: amount consumed.

That latter variable can change in two ways. First, we can ask Americans to drive less by using more public transit, bike lanes and toll-free HOV roads. But this type of cardigan sweater sacrifice—conservation—tends not to sell well to consumers and especially to politicians. Second, we must increase the efficiency of the vehicles we drive. Efficiency and conservation are not the same thing; efficiency is doing the same with less and conservation is doing less with less.

We will no doubt here from Rep. Issa and other Republicans that the new standards will either put John the plumber into a Yugo or force him to buy a truck he can’t afford. Such arguments have been heard and disproved before—for example, with seat belts and air bags. Nevertheless, it may come as a surprise to some that such demagogic calls also display a fundamental lack of faith in the market.

High gasoline costs hurt families and businesses and otherwise weaken the nation. The government should do something about it, and focusing on efficiency is the best way forward. It simply won’t be long before Joe and Bob will both be saving money as they drive from job to job, enjoying freshly brewed smart-phone coffee.
 
Ballentine is the president of Green Strategies, Inc. and a PPI senior fellow. He was a senior energy and environmental advisor in the Clinton White House.


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