Economics - Headway

Standard 4.  Economic systems differ in the ways that they address the three basic economic issues of allocation, production, and distribution to meet society's broad economic goals.

Benchmark - 9.2.3.4.1 - Explain how the availabilty of productive resources and technology limits the production of goods and services.

When gasoline prices began pushing their way over the $4.00 per gallon mark, President Obama took heat from the right, just as President Bush took the heat for the 2008 price increases. That's politics. Among the most famous observations by Carl von Clausewitz was his declaration that "war is an expression of politics by other means." If this is true, then the war of words for the hearts and minds of the electorate makes the converse, politics is just war by other principles, equally true. Truth itself has a way in such a war to become lost in another of von Clausewitz' popular rhetorical inventions, the fog of war.

As disingenuous as their critics were, neither president, Bush or Obama, received credit once prices again fell—and with good reason. It would be equally disingenuous to take credit for something over which the president has no control as it was to blame him. Just for the sake of clearing the debris from the battlefield, it seems it would be helpful to put this talking point to rest, so answering the question of what drives the cost of gasoline seems worth looking into for the sake of clarity.

The price of oil, and subsequent cost of gasoline at the pump, is governed, like other commodities, primarily by the law of supply and demand. As simple as that may seem, the several factors that determine either become a bit more complex. Each of the two sides of the equation each has several factors. Supply is affected by production and reserves on hand during swings in demand. Production is itself a factor of oil brought in at the well and refinery capacity, each of which can be affected by unforeseen circumstance and decisions made by others.

Global politics is the principal factor among the unforeseen circumstances that affect oil prices. Both supply and demand are affected by political unrest, as in Angola, Chad, Sudan and Libya, and can affect supply bound for China, driving up the market price oil companies are able to charge globally. To then meet demand, reserves and production in North America may be diverted to the Chinese market, which subsequently decreases supply and drives up cost for American consumers.

Though simplified, the preceding generally explains why increased production in the United States did not offset world-wide demand through the first half of 2012. The decisions made by others are however the chief determinant in price, and range from government regulation to price fixing decisions by the oil cartels, like OPEC.

Albeit some will deny it, very possibly because they were paid to do so—as ExxonMobil has been know to do—speculation does play a role in the price at the pump. It does so however to a lesser degree than many believe. Two other factors related to pricing decisions should also be considered though.

The inelasticity of demand for oil (price has very little effect on reducing demand through lower consumption), and, albeit it is highly speculative, how oil companies are able to use the complexity of the petroleum markets and these factors to virtually arbitrarily raise prices to increase profits. The recent book by Pulitzer Prize winning author Steve Coll, Private Empire, ExxonMobil and American Power, reveals the power and influence wielded by big oil that can be used to influence production and price.

To illustrate ExxonMobil's power, reflect first on President George W. Bush's response when Indian Prime Minister Atal Bihari Vajpayeewhen asked why he did not "just tell them what to do?" Saying, "Nobody tells those guys what to do," he characterized a power that could ignore a 1999 cable from the United States Embassy in Chad without repercussion. Moreover, when their clients tell ExxonMobil what they want in terms of profit, ExxonMobil tells them how to get it.

When charting the roller coaster ride of price increases and decreases, a remarkable pattern emerges. There appears to be no correlation between the cost of crude and the cost of gasoline at the pump, other than a general tendency for the price curves to follow one another. While fluctuation in the supply of gasoline due to refinery output can explain some of the variation, it cannot explain price differences when all the factors are equal.

The pattern that emerges is that each decrease in price following an increase fails to fall to the same low prior to the increase. The one exception is the decline in prices late in 2008. In example, the price at the pump during that fall reached the mid $2.00 range as the price of crude declined through $80 per barrel, but is at the mid $3.00 range with crude coming in at $84 per barrel in June 2012.

The fact that the pattern began to emerge in the mid 1990s, when the political climate also proffered virtual license to take profits at will, is likely no coincidence. Then, considering ExxonMobil's record profits since 2008 and the near doubling of its profits in 2010, it should take little stretch of imagination to conclude that the demand inelasticity for oil has allowed them to set prices that allow them to meet a predetermined level of profit.

Several factors make a political solution untenable. Neither price controls nor breaking up ExxonMobil will work in a global economy in which it's major competitors, British Petroleum and Shell, are outside the reach of American political fiat. The one measure that could break the hold on the consumer's purse enjoyed by big oil would be for the American consumer to remove political obstacles from investment in research and development of alternative fuels, and hybrid and fuel cell automotive technology.

Since the major oil companies are not unaware of the trend away from fossil fuels, and are themselves working to build their empires around the technologies, the consumer needs now more than ever to vote Republicans especially into political obscurity while the opportunity for development of a competitive alternative energy sector still exists.

Questions:

 1.  Which President is to blame for the rise or fall of prices?  Why?

2.  How does global politics effect the price of oil?

3.  How was President Bush's response to the Indian Prime Minister reflect the power that big oil companies have?

4.  Why wont price controls on oil work in a global economy?

5.  What biases does the author of this article have?