Saturday, May 10, 2008

hillary’s gas problem: part 2

Late Thursday afternoon I was reading various stories at wsj.com when I ran across a blog about eliminating the excise tax on gasoline. Apparently there are no economists that anyone can find who support eliminating the tax. Even those who are economic advisers to either John McCain or Hillary Clinton do not support this. Clinton did not even seek the advice of any economists. Pure politics is what is behind the whole excise tax elimination idea.

Most economists do not think removing the tax would result in a fall in the price of gasoline. The most optimistic and most extreme estimate suggests that gasoline prices might fall as much as 6 cents. That means that the oil companies would still get to keep 12 cents out of the 18-cent tax cut.

However, the consensus among economists is that the fall in price will be somewhere between zero and close to nothing, therefore close to a pure gain for the oil companies.

I mentioned this at the dinner table that evening and it surprised me that my usual dinner companions found this did not make any sense at all. Now if you know those with whom I usually share my evening meal, you know that they are smart people, certainly smarter than I am. We had a long discussion. I not only had problems seeing why they came to a different conclusion but also found it difficult trying to make sense to these bright folks.

Hey, if this doesn’t make sense to you, you are in good company.

So why won’t the price of gasoline fall much, if at all? Let me give it a go. To start off, please realize the only way the gasoline price will fall (other things being equal) is if more gasoline is produced. If the price fell, people would buy a bit more gasoline. There needs to be more gasoline to buy.

What if U.S. refineries are operating at capacity and can’t produce any more gasoline? Removing the tax will make selling gasoline more profitable by 18 cents a gallon. The oil companies would want to sell more and take advantage of this opportunity. However, there is nothing they can do because they are already producing as much as they can. To increase refining capacity would take years. Therefore, since they cannot supply more gasoline to sell, and as discussed above, then the price will not fall at all.

Look at it this way: Why would oil companies sell the same amount of gasoline for less when they can continue to sell it all at the current price?

Nothing would change for consumers. Same amount of gasoline on the market. That means the same price. However, the oil companies get to pocket an extra 18 cents a gallon.

Now what if the oil companies could squeeze a bit more gasoline out of their refineries if they got to keep some of the extra 18 cents afforded by the tax removal? Maybe they could import more refined gasoline if we make it worth their while? Then price could fall, but not by very much. Why? The increase in the quantity of gasoline would not be very much so the fall in price would not be very much.

To quote the economist who came up with the 6-cent fall in price, "...I think it is safe to say that we stand firm in agreement that this is a bad, bad idea."

If this still doesn’t make sense, please share your thinking with me.

Be blessed.
RB

1 comment:

MexicoAndUs said...

I agree with you.

I posted about the market forces driving the price of gas, and the not the big oil guys. They take advantage of the market price in profit, but they cannot create the market price.

If the market price of gas at the pump is $3.75, and one big oil company decided to sell their oil at $4.75, as some speculate they do, other big oil companies are not compelled to follow suit, because the market price is not $4.75.

The customers would flock to the $3.75 market priced companies, and the $4.75 guy would find his profits drying up, so to speak.

Some would speculate that their is collusion, and all the oil companies move their prices together agaginst the will of the market.

If that were the case, it would only take one upstart to keep his prices low and become the big cheese in a short time. Tempting. Too tempting.