About half the time, I read about a politician investigating high gas prices I roll my eyes, the other half the time I cringe. I understand why they do it: it’s a meaningless activity that could please voters (hence the eye-roll) because the majority of people have no idea what causes gas prices to be what they are (hence the cringing). I’m going to try to explain high gas prices, record profits for oil companies and why, if anything, gas prices are artificially low. Plus, what this all means for transportation policy.
One of the most common misconceptions about rising gas prices is that because an oil company makes record profits, this means they are gouging customers. This represents a fundamental misunderstanding of the basic rules of economics: price is equal to marginal cost. Oil companies make a lot of money each time oil becomes more difficult to find because the they can sell all their current oil at the price of finding a new barrel of oil.
Some oil is very cheap to extract (picture Beverly Hillbillies and the gun shot that made Jed Clampett rich), some oil is sort of hard to extract (shallow-water off-shore drilling), some is a massive production to extract (Alberta Tar Sands) and some more is incredibly difficult to extract (deep-water drilling such as the Deep-Water Horizon rig that exploded last year). It might cost nearly nothing to extract the cheapest barrel of oil, but more or less all of that has been or is being extracted. It is very expensive to find and extract a new barrel of oil because of where new oil discoveries are (deep under the ocean, etc.), and because at some point – likely very soon – we’re going to hit peak oil. This causes all oil to become priced higher, because oil companies need to ensure each barrel of oil is profitable.
A common rejoinder to this argument is that oil is next being sold in a free market, it’s instead being controlled by a powerful international cartel named OPEC. What’s interesting about OPEC, is their motivation is to protect oil producing nations whose only special skill in energy production is that they land beneath their feet is full of oil. These nations’ primary objective is to ensure they can make money on oil for a very long time, which means they want profitable oil and no alternative to be found. This is why you read things like Prince Alwaleed of Saudi Arabia saying the ideal price for them is oil in the $70-$80 a barrel range, and Saudi Arabia increasing production to stabilize prices. If anything, OPEC is over-producing oil to keep prices low and stable so alternatives aren’t found.
What does this mean for transportation? Well, two things. First, alternative energy is going to be needed one way or another because we’re actually burning through oil supply faster than a free market would let us. At some point, the artificially low prices won’t be sustainable and prices are going to skyrocket. This means both alternative power sources, and alternative transportation modes. Secondly, we’re in huge trouble if our transportation investments continue to be tied to oil consumption. At both the state and the federal level, most of our money for transportation comes from per-gallon gasoline taxes. We’ve already seen a drop in gas tax revenues as people have finally begun to drive less, and we’re going to see a further fall as gas prices rise even more, and that will mean even less money for investment.