Friday, June 27, 2008

Where Are the Gas Lines?

The next time you hear someone complaining about how “speculation” is driving up oil and therefore gasoline prices, ask him what exactly it is that he misses about this:

In the story Silver Blaze , Sherlock Holmes mischievously asks Inspector Gregory to give some thought to the dog that didn’t bark – which is now taken to mean any incident that doesn’t happen and is therefore informative in some non-obvious way. An event that is currently not happening, despite very high oil prices, is long gas lines a la the 1970s. I can remember when I was a schoolboy listening to my mom talk about having to go to bed early so that she could get up at 5:00 the next morning and go buy gas before it ran out for the day. (Back in those days gasoline stations generally did not have convenience stores, and were not open around the clock.)

The primary reason today’s moms and dads in America do not suffer that fate is that oil and gasoline prices were deregulated at the onset of the Reagan administration. This meant that when gasoline became harder to get, prices could go up and tell people that the consequences of their choosing to use gasoline were higher than they used to be. And so at a time when rapidly growing economies in the developing world have much higher demand for oil, and when more and more of the world’s oil supply is under the control of governments , whose incentive structure causes them to postpone needed investments, extract the oil as fast as possible to keep the electorate pacified so that they will still be in power when they wake up tomorrow, and replace skilled managers with political cronies, gasoline is always there when we want it.

Of course, we have to be willing to pay the price that the vendor is asking, which is much higher than it used to be. This is, in an almost magical way, solving the problem of greater competition for less oil in the only way that it can be solved – not through a gigantic central-planning apparatus, or showboating congressional hearings, or legislation against the usual suspects, but by allowing individuals to decide whether a given use of a given amount of gas at a given time in a given place is worth the sacrifice or not. Americans are thus making what economists call marginal adjustments – they are one at a time buying fewer and fewer SUVs, they are deciding whether that extra trip is really necessary, they are riding buses and trains more to work and driving cars less. Higher prices are leading to less consumption, just like a blackboard model predicts.

But another development that has made it easier to reconcile all the people who want gasoline with the difficulties of providing it to them is the vast increase in the complexity of the oil trading market since the early 1970s. Back in those days, oil was generally produced by big Western oil companies, who made long-term contractual commitments to governments who due to blind luck happened to preside over the territory where the oil could be found. But the shortfalls of the 1970s generated a vast market in oil futures and other financial instruments that maybe it easier both to hedge against unexpected supply disruptions and to inform potential buyers farther in advance that consumption of oil in the future would be more (or less) costly than they thought.

It is thus especially irritating, if not exactly surprising, to hear politicians, few of whom have ever had to solve a problem remotely as complex as the problems that oil company managers solve every day, going on and on about how “speculators” are driving the price of gasoline up. People who talk this way do not generally have a precise theory of how exactly this happens. Presumably, the chain of causation has a “speculator” buying an oil futures contract secure in the knowledge that the very act of his doing so will drive the price up, allowing him to sell that contract later and make money. Oil “speculators” in other words have some sort of mysterious license to make money that the rest of us are too dumb to catch on to.

But for every oil “speculator” who buys an oil contract on the assumption that he will make money off it later, there is another “speculator” who is selling the contract on the assumption that he will lose money if he keeps it, because the price is headed down. Each trader is reacting on the basis of some data that he possesses, and only the future will tell which one is right. It is true that the decision by one “speculator” to increase his offer for an existing contract applies pressure to increase the price. It is equally true that this increase informs anyone who wants to pay attention that oil will be more expensive than he previously thought, giving him incentives to economize on its use. “Speculators” who make money at any particular moment in time are being rewarded for the things they thought they knew that are true, and those who lose money are being punished for the things they thought they knew that are in fact wrong. They are behaving no differently than the student who chooses to take my class or not on the basis of what he expects to gain, than the young family deciding whether to buy a particular house because they think the neighborhood is either good or going to get better, or the voter who decides whether or not a particular politician merits his trust. All of them are gambling, and the essence of gambling is not knowing everything about the future that we wish we knew.

The collective force of what oil "speculators" know that is in fact true is a kind of free gift to the rest of us, who are able to plan our lives more effectively with this new information about whether gasoline is likely to be more or less dear in the near future. The consequence of going after “speculators” (for example, by limiting their creativity in the kinds of contracts they create) is that they reveal less of their private information, making it the oil market function less effectively. Whenever “speculators” are blamed, and that blame is successfully encoded into the law, bad things happen. Politicians, of course, generally advance their careers by pointing fingers, and so social disasters are like manna from heaven to them. In rain or shine, politicians will always get theirs . It is those of us stranded out here in reality, who actually have to make sacrifices (whether paid as money or time in a gas line) to get things like gasoline who have to bear the consequences of this kind of decision-making.



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