Peak oil and taxes

May 22, 2006 | 22 comments
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On the Urban thread, Jonathan Green pointed out that the major issue with oil scarcity may not be how much oil we have in the ground, but how much we can pump in a given year. If we are maxed out on supply for a year, any oil disaster creates a huge crunch. So once we hit peak capacity, we’ll end up with large price spikes anytime supply is interrupted anywhere. This creates risk for consumers that they’d rather not have, and so markets tend to give people options to get rid of that risk, at a price.

One solution to these price spikes is that higher prices will signal that there is money to be made in stockpiling and waiting for a high price (buy low, sell high). This would mitigate the price spikes by creating extra stockpiled capacity when bad things happen. It is similar in spirit to opening the strategic petroleum reserves when prices get high, except without the politics.

Except, of course, for the politics! Because if you stockpile oil to sell when prices spike, not only are you providing a public service, you are hoping to receive “windfall profits”. In fact, those windfall profits, in a well-functioning market, rise precisely as your stockpile-selling is valuable to others.

So one effect of a large tax on windfall profits would be to reduce the incentive to stockpile (since those profits will be taxed away). Nor, really, are the profits likely to be a “windfall” in any meaningful sense. The stockholders get those profits because they took on the risk of oil prices so consumers would face less risk.

So I’m not in favor of that kind of taxation. On the other hand, if we think oil is creating all sorts of nasty externalities, like pollution and national security problems, then I’d favor higher gas taxes. Ideally, the size of the tax would reflect the social cost created by the gasoline. Even better would be to create a market in automobile emissions, but I don’t think we’re quite there yet.

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22 Responses to Peak oil and taxes

  1. JustaGuy on May 22, 2006 at 3:49 pm

    “Nor, really, are the profits likely to be a ‘windfall’ in any meaningful sense. The stockholders get those profits because they took on the risk of oil prices so consumers would face less risk.”

    A revealing redefinition of “windfall” there. So owners and stockholders who are able to stockpile oil to sell when prices are driven to extreme heights by a crisis in oil availability, and thus are in a position to personally benefit from that crisis, are not in fact seeking to maximize that opportunity when they so act, but rather are–what, accidentally? unexpectedly? against their wishes?–gaining greater than usual profits while meaning to provide a “public service”? Interesting. So, I guess beside those one or two nefarious (and easily dismissable) price-gougers out there, all is well.

    Of course, since this is a blog dedicated to Mormon themes, perhaps one could turn to King Benjamin, and ask whether the scriptures have anything to contribute to the moral question of just how it is that certain persons manage to get into a position that allows them to benefit enormously (and with an apparent dispensation of economic altruism, no less) from the fact that many other persons are not in their position, and thus are wholly subject to financial and environmental vicissitudes that are not of their making and are utterly beyond their control. In other words, perhaps one could ask the question whether “windfall” profits, whether or not they are the consequence of unintentionally ameliorative practices, are not also evidence of the world described (and condemned) in D&C 49:20.

  2. Jonathan Green on May 22, 2006 at 4:37 pm

    So, Frank, it looks like you’ve gauged the politics of stockpiling commodities pretty accurately.

    Is there an economic definition of price-gouging or crisis profiteering? How much of the market does one have to have in order to create artificial scarcity or corner the market? Is it even possible with a market and distribution system as large as that for gasoline?

    I wonder–and hope we never find out–how this works out in terms of food storage: “now that I’ve mowed down them unprepared neighbors coming to take my barrels of wheat, I’m taking my AK to fill up the car with gas from the storage tanks of those price-gouging, crisis-exploiting corporations”? or, “Honey, look, the neighbors are here, they’re armed and hungry, and they hear that Mormons have food in their basements”?

  3. Frank McIntyre on May 22, 2006 at 5:22 pm

    Justaguy,

    Are you worried about people cornering the market or about people making a profit? I agree that cornering the market to create scarcity and drive up price is bad— that’s a standard monopoly tactic and is socially inefficient. I’m not talking about a monopoly, though. It is very hard to do in a competitive market. So a key to avoiding this problem is encouraging competitive markets.

    But I am guessing there is more to your complaint. You are worried that some people make money during a crisis, but surely your concern is deeper than this. Band-aid makers make money when I skin my knee. They, in fact, rely on me skinning my knee in order to make money. Could you clarify how your criticism applies to oil and not to band-aids (for example). And remember, I am not talking about monopolies, which I don’t think need exist in gasoline storage. Thus this is not the creation of artificial scarcity.

    JG,

    You ask if there is a definition of profiteering. I think the typical answer would be if one is exercising “market power” such that one gets a higher price as one sells less. This probably happens at least to a small extent in many markets. Normally, I would say that the oil market is big enough to avoid these sorts of problems, but since so much of it is government controlled, perhaps not.

    The nice thing about my example, though, is that it is about the stockpiling market. As long as there is free entry into that market, it should be able to act efficiently and competitively, which means you can’t monopolize the market and so you can’t profiteer (in that sense).

  4. MikeInWeHo on May 22, 2006 at 5:36 pm

    “…there is money to be made in stockpiling and waiting for a high price (buy low, sell high).”

    Doesn’t the Futures market do that already? The only reason Southwest Airlines has avoided the losses even other highly efficient airlines such as Jet Blue are experiencing this year is because it made brilliant hedging moves in jet fuel years ago. Essentially, Southwest stockpiled jet fuel at much cheaper prices. Once those “virtual” stockpiles run out, they’ll be facing a squeeze too.

    I used to work near the Mercantile Exchange in Chicago. The colorfully-jacketed traders on the floor there are busy stockpiling lots of basic commodities already. Don’t know what crude oil futures are trading at right now; probably don’t want to know!

  5. Frank McIntyre on May 22, 2006 at 5:57 pm

    MikeInWho,

    The stockpiling is the physical side of the market, the futures market would be its financial analog. So yes, I think you’ve got the idea. Last I heard, oil futures are running about the same as current prices, out for several years. Of course, there may nopt be a lot of info in that market due to the volatility, which is why Southwest pays those people to take the risk off their hands (and farmers do the same thing).

  6. cadams on May 22, 2006 at 7:23 pm

    I’m not a commodities expert, but have any of you followed the oil industry activity now in Utah? The Uintah Basin is booming; once sleepy, dusty pioneer towns like Vernal, Duchesne and Roosevelt are bustling with activity now. There was a brief boom in the early 80s before oil prices dropped.

    These companies seem to be getting readily available oil based on a recent oil find in 2003 near Richfield. But what’s going to happen if the vast oil shale gets extracted?

  7. Mark Butler on May 22, 2006 at 7:26 pm

    From what I understand oil shale is not profitable even at current oil prices, and what little activity there is relies on government subsidies in the same perverse manner as ethanol.

  8. Seth R. on May 22, 2006 at 8:31 pm

    Actually,

    The peak of this past year’s high gas prices was exactly where the price SHOULD have been if the prices had been following general inflation like every other consumer good.

    The price Grapefruit, for example has grown even more than gasoline over the past 40 years. The same is true of most consumer goods.

    So three bucks a gallon was actually about where the price of gas was supposed to be, adjusting for inflation.

    But grapefruit prices aren’t shouted from every street corner. And grapefruit doesn’t constitute such a large chunk of the family budget. So nobody really notices. But prices have gone up across the board. Gas prices have been ARTIFICIALLY surpressed for the past thirty years giving the American public an unrealistic sense of entitlement.

  9. El Jefe on May 23, 2006 at 1:17 am

    Of course, there probably isn’t a better definition of windfall profits that those people living in coastal cities where real estate has gone up 20% a year for the last 5 years or so. I am sure that those who are most concerned about “windfall profits” would be the first to sell at far below market price in order not to take advantage of buyers.

    Oil supply is relatively inelastic, and so is demand; which is why prices spike so much during shortages. But if all families in America were to make the decision to curtail driving by 10%, that would have more effect on bringing down the price of oil than all the postruing over windfall profits.

  10. JKS on May 23, 2006 at 2:14 am

    LOL, it’s a pretty good thing I don’t have anything against windfall profits, El Jefe. I happen to appreciate my home equity in my coastal city.

  11. a random John on May 23, 2006 at 3:04 am

    Seth R.

    Gas prices are always artificial because of OPEC.

  12. Seth R. on May 23, 2006 at 8:51 am

    A lot of OPEC’s behavior is due to political pressure from its client nations, like the US. There are a lot of variables.

  13. Mark B. on May 23, 2006 at 11:01 am

    One reason demand for oil is so inelastic is that development of housing and industrial and commercial property for the past half century is based upon the expectation of a virtually unlimited supply of low-priced oil.

    It is not easy to convert a bunch of 5,000 sq. ft. single family homes on one acre lots to denser housing that would allow alternatives to automobile transportation. The New York Times had an article last weekend about the squeeze being felt by the two-hour commuters–from South Jersey, the Poconos, and Sullivan County–who built large houses in those areas (at prices they could afford), but are paying for it in commuting costs. Since those costs are significantly higher now than they were a year ago, those folks are getting squeezed, and there’s not much that they can do about it in the short run.

    Sprawl (urban/suburban/exurban) is a much greater externality than congestion or air pollution. Pollution per mile driven has fallen substantially in the past 30 years, and will continue to fall as cleaner engines, including hybrid cars, are produced in greater numbers. Congestion can and will be reduced as high fuel prices cause people to car pool, make fewer trips, etc.

    But you cannot easily redevelop a sprawling mess like Los Angeles or the Wasatch Front into a city or collection of cities that would “work” without universal (or nearly universal) use of automobiles for almost all trips–to work, shop, church, etc. Since there’s no reason to expect that episodes of peak oil use will be less frequent in the future, we should get used to a regular diet of price spikes.

  14. Frank McIntyre on May 23, 2006 at 11:14 am

    Mark,

    It is not clear to me that “sprawl” by itself is a well defined externality. I suppose if you just plain hate seeing big houses, then that is certainly an externality. But, removing the congestion and pollution problems, what is the cost I am imposing on my neighbor by building a house with a big lawn at the edge of town?

    I can think of a few– it takes them longer to get to the country-side (but this is really a congestion complaint, right?). On the other hand, greenery appears to matter to people mostly if it is very close. Which is to say that people like parks close to them, something urban sprawl can accommodate even though it doesn’t always.

    Perhaps I want small, local, stores and I blame sprawl for their lack. But there is a merket for small, local stores and their lack indicates that I am not willing to pay enough to have them operate. But I am not sure that this is best thought of as an externality so much as a simple preference. There are some fixed cost issues, but those issues arise in spades with big stores, and people are willing to pay those fixed costs. Thus the small stores just appear to have lost out in terms of what people want. So I don’t see a big externality there either.

    So tell me Mark, besides the classic traffic and pollution externalities, what are the ones you are thinking of when you speak of sprawl?

  15. Greg B. on May 23, 2006 at 5:23 pm

    Frank, you are correct. Sprawl by itself is not a well defined externality. But the costs of sprawl regularly include more than pollution. Greater levels of stress, weakened sense of community, higher energy consumption, and lessened historic preservation are all associated with sprawl. Sprawl can also be aesthetically displeasing. Just because we have a difficult time placing a fixed monetary cost on certain effects does not mean they are value free.

    Of course, sprawl has benefits like lower crime rates and meeting the average American’s desire for lower-density living.

  16. Dan Richards on May 23, 2006 at 5:47 pm

    There was a fascinating piece on oil shale on Morning Edition this morning, featuring my old seminary teacher. I can’t link directly to it, but you can probably find it here.

  17. Dan Richards on May 23, 2006 at 5:49 pm

    Hmmm, I’ll try that again. HERE

  18. Frank McIntyre on May 23, 2006 at 6:02 pm

    Greg,

    In fact, you can put a monetary cost on sprawl just like you can on snickers bars. And you can put a benefit on it as well. Those are not “fixed” in any sense, but neither are any other prices of the things we buy. Prices are outcomes of the negotiation between the cost to the producer and the benefit to the consumer (supply and demand).

    The reason to treat sprawl differently than snickers bars is if it imposes some externality on others that the markets aren’t capturing or can’t be made to capture. Pollution and traffic are two examples of this, although we’re getting closer to being able to run markets in those and so eliminate the externality.

  19. Nate Oman on May 24, 2006 at 10:37 am

    Frank: I agree with you that markets will be able to price a lot of the “costs” of sprawl. It seems to me, however, that there is a basic question of how efficient the market is that is generating those prices, given the fact that many aspects of development are made on the basis of political rather than market decisions and involve massive government subsidies. For example, the size of lots and the houses that can be built on those lots is a decision that is generally made by zoning boards rather than ordinary market processes. Likewise, freeways constitute a massive government subsidy that is likely to have distorting effects.

    (And lest Mark B. and the rest of the Brooklyn-is-more-righteous-than-you-are folks take heart, I would point out that places like NYC are also built on the back of massive government subsidies and regulations. Also, for what it is worth, I have felt a much greater sense of community in suburban Virginia than in Sommerville, Massachusetts, the most densely populated city in the Commonwealth.)

  20. a random John on May 25, 2006 at 12:32 pm

    Nate,

    Do you speak Portuguese? Because it really helps one feel at home in Smmerville.

  21. Frank McIntyre on June 6, 2006 at 4:56 pm

    Nate,

    WHat you’re saying, to me, is that one needs to add in a TIebout model of local competition among (local) governments. And that is probably right.

  22. juan on June 9, 2006 at 9:38 pm

    Since the subject seems to be oil pricing, I’d consider that it’s worth thinking about something that Matt Simmons, Simmonsco Intl., wrote in a 1998 research paper:

    “For all those that fervently believe price movement always reflects fundamental changes in physical markets, the discussion in this paper bears careful reading. Our work strongly suggests that large swings in the funds’ net position in oil contracts on the NYMEX have driven virtually every significant movement of crude oil since the MG position was unwound in early 1994. The single exception was a brief period in the fall of 1996 when physical tightness in the market itself set the price of oil.”

    Price formation in the crude oil market has become increasingly divorced from real world economic fundamentals but most people insist on maintaining the myth of market efficiency. We are in fact talking about speculative pricing that has little to do with actual production-supply-demand.