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Gas is too cheap

Maximilian Auffhammer, professor, international sustainable development | February 4, 2016

Readers of this blog are likely aware that oil is really cheap right now. While in July 2008, the U.S. benchmark price peaked at just above $140 a barrel, its price dipped to below $27 in mid-January.

The Internet is on fire telling us that a barrel of oil is now cheaper than the equivalent volume of Perrier sparkling water or Coca Cola. But there is a much more frightening comparison: The national average price for gasoline is $1.80 this week, with a minimum of $1.29 in Tulsa, Okla.

gas prices graph

The external costs for a gallon of gasoline, as estimated in a now classic paper, are approximately $2 per gallon. This means that the average American is currently purchasing gasoline at half of its true social cost.

Now, higher oil price won’t fix the external costs, of course, and we have argued ad nauseum on this blog for a carbon tax to fix one of the market failures. Michael Anderson and I have a nice paper suggesting that one would need to charge a gas tax somewhere significantly north of $2 to make drivers internalize all of the external costs you spew on your fellow citizens faces while hurling your Dodge Hellcat down I-80 at rush hour.

But low gas prices have all kinds of negative effects for a society that does not properly tax gas. People drive more and hence cause more congestion. People purchase less fuel-efficient cars, since they think gas prices will always stay where they are any given day, which is rational. (What is not rational is that folks buy more convertibles on sunny days.) So we drive our bigger cars more on a road network that is falling apart. Bridges and highways are in terrible condition, as has been documented widely.

Stop the presses!

The smartest energy economist I know, an Energy Institute colleague, Severin Borenstein, suggested a perceived outrageous solution to this problem a while back: a price floor for gasoline. Stop the presses! A neoclassical economist suggests a price floor?

car fueling up

(Rama via Wikimedia Commons)

My version of the idea goes like this: If the price of oil drops below a certain price, say $70 per barrel, gas prices get frozen at the average local historical price for $70 oil. Yes, we would keep gas prices artificially high. This would discourage consumers from driving more and maintain disincentives to purchase really fuel-inefficient cars.

But what to do with the profits? Give it to refiners? Oil companies? No. The idea is for the regulator to capture this windfall and use it to put our highway system back together or improve public transportation systems.

You are shaking your head. Well, the Chinese are not. In the first week of January, the National Development and Reform Commission (which is China’s economic planning agency) announced that the price of diesel and gasoline would not be lowered as long as the price of oil is below $40.

This is a big deal. China had 279 million registered cars in 2015; in the U.S. the number is 257.9 million. Due to regulatory controls, the market for gasoline is less complex in China than in the fragmented U.S. market. So how one would calculate the exact floor by region would be subject to lengthy regulatory processes.

Still, the basic economics are right. While I agree that the tightened CAFE standards will improve fuel efficiency, they will not generate revenues that will prevent our then smaller and lighter cars from falling in to giant size potholes. Let’s get on it.

Cross-posted from the blog of the Energy Institute at Haas (tag line: Research that Informs Business and Social Policy).

Comments to “Gas is too cheap

  1. Supply and demand are the basic tenets of our economy. Establishing a price floor would only ensure government wasting or misappropriating the profits collected. This can be seen in everything the government had its hands in, as seen with bridge tolls, gas taxes, and social security, to name a few. Let’s not give them something else to add to the list.

  2. It is time to use demand management measures for internalizing external costs of over-using cheap gas. A cost-effective approach could be imposing gasoline tax, provided tax revenues are used efficiently.

  3. ——- cars/SUVs are the bane of our downtown communication. How do people rationalize buying a blimp that they have to park on the street in front of their house “cause their garages are full of ‘stuff'”? . . .

  4. Sadly, I’ve noticed it’s getting ever more difficult to back out of parking spaces because my hybrid vehicle is typically surrounded by huge new SUVs and trucks. People are being lulled into believing the current gas prices will be here forever and car dealers will naturally have more difficulty selling electric/hybrid cars in this cheap fuel environment. Traffic congestion is a problem, pollution is a concern (asthma, lung disease) and the public now has less enthusiasm for renewable energy program.

    This is such a backward step! The Administration should be offering suggestions to states that this might be an opportunity to increase gas taxes (that could be used for renovating public schools). We need to do more to balance the message this unusual economic occurrence is sending to the average citizen. I think it is a missed opportunity.

  5. There are more reasons to support higher fuel costs: It encourages production in the U.S. This has the benefit of reducing our dependence on imported oil and not providing the Saudis with the funds to continue to support extremist Islamists around the world.

    I suggest we create an import duty on oil to maintain a U.S. cost of $70/barrel. That would generate a lot of income to support alternative fuels and development, as well as sustain U.S. production.

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