Tuesday, October 03, 2006

Drilling Fees and Oil Markets

A stimulating advocacy piece in Wired by Vinod Khosla on ethanol as the “fuel of the future”. It warrants more investigation no doubt. Here is something that sticks in my craw, however. The piece generally adopts the language of good, old-fashioned entrepreneurial enterprise and free market thinking, which is great, but then, in the midst of a discussion of a proposed fee for oil companies drilling in California (Proposition 87), he pulls out this bit of wizardry:
Prop 87 will not raise gas prices as the oil companies would have you believe. Market forces ensure that world oil prices, not production costs in California, determine gas prices. Besides, the California attorney general has confirmed that Prop 87 makes it illegal for oil companies to raise gas prices or pass the fee on to consumers. The US Supreme Court has already ruled that states can prohibit oil companies from passing drilling fees on to consumers.
It may be true that these fees would not be significant in the overall world oil market, but this law against passing on fees is highly suspect. The California attorney general and SCOTUS are powerful entities indeed, but they do not have the ability to repeal the basic laws of economics, do they? Any time you see the phrase “law prohibits company X from passing on fees for Y to consumers” then something pretty much has to be out of whack. The only way for government to fix prices is to, well, fix prices—i.e. set them with price controls. Other than public utilities, I don’t think this has been done on any wide scale since the Nixon administration, and I think that Nixon’s policy is almost universally considered a failure. If the government is not actively setting actual consumer prices, then any law “prohibiting companies from passing on” a given cost to consumers will just mean that companies cannot create a line item surcharge for that cost. But the cost will still be there, it has to be born by someone. The implication of the argument is that is the fees will come exclusively out of corporate profits, or employee compensation at oil companies, but there is simply no way to enforce that or show that it will actually happen. Expenses, revenues, and profits in any business of any size and complexity simply can’t be micromanaged by some government policy, however well-intentioned, unless the government just takes over the business—i.e. blatant socialism.

I hate to dwell on one thing, but it is rather disappointing to see this in what would otherwise be a very exciting article. I’m not opposed to Prop 87, nor for it; I don’t know enough about the details. In principle, it sounds fine, especially if this really just applies to drilling on public land. But it’s more than irritating to see this blatantly non-economic argument intruding on an otherwise exciting article. It tends to undermine the author’s credibility and make me question the rest of his argument.

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