I just filled up my car’s gas tank. Like everyone else, I cringed when I saw the final price. It hurt.
Really, it did. Economic theory discusses a concept called the “pain of paying”. In perfect theory, the reluctance to spend a dollar should be the same for every dollar spent. In practice, some dollars are much harder to spend than others.
When it is obvious that we are giving up something, such as paying in cash, an MRI of the brain at that moment will show that the brain’s pain centers are being activated. (These tests have actually been done.) When the payment is less obvious, such as a credit card, the brain’s reaction is less intense. We know that it is costing us intellectually, but it doesn’t feel like spending, so we don’t care as much.
The government understands this principle thoroughly. That is why the vast majority of all taxes we pay are hidden in something else. Read your phone bill or the small print on your pay stub sometime.
But, back to gas. Gasoline is the only thing we buy that has its price posted in large numbers on almost every street corner. As we pump it into the car, we watch the price race up with each brightly lit penny being added to all the pennies before.
It’s not the swipe of a credit card, or even the rustle of a bill, it is a flashing number that screams: you are paying for this! It becomes the symbol for the unease we feel about our country’s future.
So, it really hurts, and people are reacting to the pain. With no shortage of oil in the world, it seems as if these price increases are coming from out of the blue. People understandably want to know why.
The politicians are quick to answer. It’s all the fault of greedy oil companies and even greedier speculators. If we just find some way to tax and regulate them more, we will all be happy for the rest of our lives. Of course, the politicians won’t bother explaining how raising the cost of producing gasoline will lower its price.
If you pin them down, they will point their fingers toward you. For the iron law of politicians, embedded deep in the DNA of everyone who has ever hogged a microphone is the credo that has been borrowed by the CIA: “Admit Nothing. Deny Everything. Make Counter-Accusations!" Nothing is as important as finding an excuse to raise taxes and increase government power.
What’s really happening? Gasoline prices are the product of a very complex interaction of many different factors, many different types of oil, and constantly shifting demand.
Before looking at those factors, the first, most important, concept is that the price you pay today represents an estimate of what the price will be in the future—not the costs of the past. The refiners, who are the ones who convert oil into gasoline, must replace the oil they use with new oil so that they may continue to make gasoline. They must price the gas at a level that will allow them to buy a volume of oil that will replenish their supply; regardless of what they paid in the past. This is not speculation. It is a requirement to stay in business.
The second important concept to understand is that, after the cost of oil, taxes represent the next largest component of gasoline prices. At current prices, greedy, selfish oil companies make about 8 cents profit per gallon, and the loving, friendly government about 60 cents; 750% more. And, since taxes are based upon a percentage of the price, the government’s take will increase as the price increases.
But, setting taxes aside (I wish I could.). What are some of the more important strategic considerations that drive up the expected price of oil?
The first is that oil is priced in U.S. Dollars, wherever in the world it is bought. In the last three years, the value of the dollar has fallen by about 15 percent. As a result, the dollar has fallen from the second strongest currency in the world, after the British Pound, to the sixth. It is now worth less than the Euro, the Swiss Franc, the Canadian Dollar, and the Australian Dollar. Even if nothing else affected the price of oil, it now takes more dollars to buy a barrel than it did just a few years ago.
Indeed, the outlook for the U.S. economy and currency is so doubtful, that a number of the leading nations are actively considering no long using the dollar as the world’s reserve currency. If and when that happens, prices of every import—including oil—will skyrocket.
Another major consideration is the domestic supply of oil. Now that the technology for extracting shale oil is becoming economically feasible, many estimate that the U.S. has at least a 200 year supply of oil reserves. Natural gas also offers huge, long lasting supplies of energy for the country. But, Washington has steadfastly refused to allow increased domestic production of oil and gas. Because there is a significant lead time for developing these resources, even if the politicians reversed course, it would be years before the increased supply had a significant impact on domestic prices.
That means that the U.S. will continue to be dependent upon energy supplies from politically unstable parts of the world. The Middle East is currently more volatile, and its future is more uncertain, that at any time in living memory. It is far too soon to know if the so-called Arab Spring will sprout beautiful tulips or thorn bushes of hatred and violence. There are certainly many forces in that area that embrace the latter world view.
Neither Washington nor Europe has shown any signs of understanding what is going on in that part of the world, or how to influence it. Leading from behind does not give one confidence that a secure path will be followed.
Imagine if you had to set the price of gasoline at a level that would ensure sufficient supply in future. The currency you use is getting weaker and every indicator is that it will weaken further. There is no realistic increase in domestic production in the future. The oil that is available comes from an area that is unstable and insecure and becoming more so. You have no control over these factors and the politicians who do are ignoring them. What would you do?
That’s right. You’d blame evil oil companies and then go off looking for another good deed to do.
Really, it did. Economic theory discusses a concept called the “pain of paying”. In perfect theory, the reluctance to spend a dollar should be the same for every dollar spent. In practice, some dollars are much harder to spend than others.
When it is obvious that we are giving up something, such as paying in cash, an MRI of the brain at that moment will show that the brain’s pain centers are being activated. (These tests have actually been done.) When the payment is less obvious, such as a credit card, the brain’s reaction is less intense. We know that it is costing us intellectually, but it doesn’t feel like spending, so we don’t care as much.
The government understands this principle thoroughly. That is why the vast majority of all taxes we pay are hidden in something else. Read your phone bill or the small print on your pay stub sometime.
But, back to gas. Gasoline is the only thing we buy that has its price posted in large numbers on almost every street corner. As we pump it into the car, we watch the price race up with each brightly lit penny being added to all the pennies before.
It’s not the swipe of a credit card, or even the rustle of a bill, it is a flashing number that screams: you are paying for this! It becomes the symbol for the unease we feel about our country’s future.
So, it really hurts, and people are reacting to the pain. With no shortage of oil in the world, it seems as if these price increases are coming from out of the blue. People understandably want to know why.
The politicians are quick to answer. It’s all the fault of greedy oil companies and even greedier speculators. If we just find some way to tax and regulate them more, we will all be happy for the rest of our lives. Of course, the politicians won’t bother explaining how raising the cost of producing gasoline will lower its price.
If you pin them down, they will point their fingers toward you. For the iron law of politicians, embedded deep in the DNA of everyone who has ever hogged a microphone is the credo that has been borrowed by the CIA: “Admit Nothing. Deny Everything. Make Counter-Accusations!" Nothing is as important as finding an excuse to raise taxes and increase government power.
What’s really happening? Gasoline prices are the product of a very complex interaction of many different factors, many different types of oil, and constantly shifting demand.
Before looking at those factors, the first, most important, concept is that the price you pay today represents an estimate of what the price will be in the future—not the costs of the past. The refiners, who are the ones who convert oil into gasoline, must replace the oil they use with new oil so that they may continue to make gasoline. They must price the gas at a level that will allow them to buy a volume of oil that will replenish their supply; regardless of what they paid in the past. This is not speculation. It is a requirement to stay in business.
The second important concept to understand is that, after the cost of oil, taxes represent the next largest component of gasoline prices. At current prices, greedy, selfish oil companies make about 8 cents profit per gallon, and the loving, friendly government about 60 cents; 750% more. And, since taxes are based upon a percentage of the price, the government’s take will increase as the price increases.
But, setting taxes aside (I wish I could.). What are some of the more important strategic considerations that drive up the expected price of oil?
The first is that oil is priced in U.S. Dollars, wherever in the world it is bought. In the last three years, the value of the dollar has fallen by about 15 percent. As a result, the dollar has fallen from the second strongest currency in the world, after the British Pound, to the sixth. It is now worth less than the Euro, the Swiss Franc, the Canadian Dollar, and the Australian Dollar. Even if nothing else affected the price of oil, it now takes more dollars to buy a barrel than it did just a few years ago.
Indeed, the outlook for the U.S. economy and currency is so doubtful, that a number of the leading nations are actively considering no long using the dollar as the world’s reserve currency. If and when that happens, prices of every import—including oil—will skyrocket.
Another major consideration is the domestic supply of oil. Now that the technology for extracting shale oil is becoming economically feasible, many estimate that the U.S. has at least a 200 year supply of oil reserves. Natural gas also offers huge, long lasting supplies of energy for the country. But, Washington has steadfastly refused to allow increased domestic production of oil and gas. Because there is a significant lead time for developing these resources, even if the politicians reversed course, it would be years before the increased supply had a significant impact on domestic prices.
That means that the U.S. will continue to be dependent upon energy supplies from politically unstable parts of the world. The Middle East is currently more volatile, and its future is more uncertain, that at any time in living memory. It is far too soon to know if the so-called Arab Spring will sprout beautiful tulips or thorn bushes of hatred and violence. There are certainly many forces in that area that embrace the latter world view.
Neither Washington nor Europe has shown any signs of understanding what is going on in that part of the world, or how to influence it. Leading from behind does not give one confidence that a secure path will be followed.
Imagine if you had to set the price of gasoline at a level that would ensure sufficient supply in future. The currency you use is getting weaker and every indicator is that it will weaken further. There is no realistic increase in domestic production in the future. The oil that is available comes from an area that is unstable and insecure and becoming more so. You have no control over these factors and the politicians who do are ignoring them. What would you do?
That’s right. You’d blame evil oil companies and then go off looking for another good deed to do.
