April 25, 2006, 6:00 a.m.
Our Gaseous Capitol

Congressional Republicans aren’t the most popular people in Washington these days. So perhaps we shouldn’t be surprised to hear Denny Hastert and Bill Frist demanding that the Bush administration investigate potential oil-industry “price gouging,” or Arlen Specter singing the praises of “windfall taxes” on oil companies. Such demagoguery probably isn’t a bad way to score quick political points. Nobody is happy paying $3 a gallon at the pump, and oil companies are perceived as the villains: In a Pew Research poll last year, 73 percent of Americans believed that the spike in gas prices following Hurricane Katrina was the result of oil companies’ taking advantage of consumers.

But if denunciations of the oil industry aren’t surprising, they are disappointing. The truth is that today’s high gas prices have almost nothing to do with profit margins on oil, and that the “solutions” being batted around — windfall taxes, price controls, anti-gouging laws — would do much more harm than good.

Before you get too outraged over what it costs to fill your tank, keep in mind that gas always gets more expensive before Memorial Day. That’s because environmental regulations require refineries to make two blends of gas: one for winter months and a cleaner one for the summer (when higher temperatures cause gas to evaporate more quickly at the pump, releasing more chemicals into the atmosphere). As refineries switch their production from the winter to the summer blends, they temporarily stop making gas, and prices go up. That said, this year’s rise has been larger than usual: Prices have shot up roughly 25 cents per gallon over the past few weeks, reflecting an increase in world crude-oil prices of about 20 percent since January.

Now there’s no question that this has been good for the oil industry. But to call its gains “obscene” — as Michigan’s Democratic senator Carl Levin recently did — betrays a gross ignorance of how the industry works. In a recent Cato Institute study, Jerry Taylor and Peter Van Doren reviewed the data and found that profit margins in the oil industry are comparable to those of other sectors. What’s more, the oil and gas sectors have actually been less profitable from 1970 to the present than the rest of the economy. Slapping a “windfall tax” on them now would amount to telling them that they must suffer losses during lean years but can’t make up for them in fatter ones.

That’s unfair, of course, but it’s also bad policy. What it would do — as would price controls — is distort economic incentives in such a way as to decrease domestic oil production. Oil companies are willing to make the huge capital investments associated with exploration and drilling because they have a reasonable expectation that the market will reward them. Diminish that expectation and you also diminish the amount of oil flowing from U.S.-owned wells. This isn’t just theory; it’s precisely what has happened whenever lawmakers have meddled in energy markets. Harvard economist Joseph Kalt found that price controls in place from 1974 to 1980 kept domestic production 0.3 to 1.4 million barrels per day lower than it otherwise would have been, and the Congressional Research Service estimates that the windfall tax on oil profits from 1980 to 1988 decreased domestic production by 3 to 6 percent.

Those are just the kinds of numbers we don’t want to see if keeping gas prices low is our goal. The only way to put downward pressure on prices over the long term is to make sure supply can match demand — and that means encouraging domestic oil and gas production, not discouraging it. Hastert, Frist & Co. have it exactly backward.

If Congress really wanted to be helpful, it could allow drilling in the Arctic National Wildlife Refuge and oil exploration on the continental shelves off the western and eastern coasts of the U.S. It could also streamline the onerous regulatory process that has kept the U.S. from building a single new refinery since 1976.

And it could undo the ridiculous ethanol mandate in last year’s energy bill. For years, Congress has required that gasoline contain “oxygenates” to make it cleaner. One such oxygenate, ethanol, is made from corn (among other things). It has accordingly been the traditional additive in the Midwest, while coastal regions have found it cheaper to use the petroleum-based MBTE. No longer. The energy bill requires the use of 7.5 billion gallons of ethanol each year by 2012; at the same time, Congress has denied liability protection to makers of MBTE, who have become a favorite target of tort lawyers. The consequence has been to end domestic MBTE production almost altogether. But since the ethanol industry hasn’t been able to pick up the slack yet, we’ve gotten shortages — and higher gas prices.

None of these policy changes will give voters that special frisson of hearing politicians beat up on an unpopular industry. But they will have the virtue of making gasoline cheaper over the long term. We suspect that’s something voters will like even more.

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