Experience shows our energy policy should continue to rely on market forces.

Some policymakers have suggested that the federal government should adopt price control mechanisms on refined products, sometimes at the wholesale level, to combat the current rise in fuel prices. Congress should reject this advice. In the immediate aftermath of both hurricanes Katrina and Rita, there were but a few reports of supply shortages or market distortion. Reliance on market forces provided appropriate market signals to help balance supply and demand even during these difficult times.Enactment of politically tempting but market place-disrupting price controls is absolutely the wrong cure for the situation. President Reagan eliminated price controls on oil products immediately upon taking office in 1981. He was outspoken about the inefficiencies and added costs to consumers that resulted from America's 10-year experiment with energy price controls during the 1970s.

The energy price and allocation controls of the 1970s resulted in supply shortages in the form of long gas lines. Studies have shown that, although intended to reduce costs, controls actually resulted in increased costs and greater inconvenience for consumers. The benefits of market pricing became clear soon after the elimination of price and allocation controls in 1981.

The U.S. Federal Trade Commission stated in an extensive study published this June that “Gasoline supply, demand and competition produced relatively low and stable annual average, real U.S gasoline prices from 1984 until 2004, despite substantial increases in U.S. gasoline consumption.” It noted that, “for most of the past 20 years, real annual average retail gasoline prices in the U.S., including taxes, have been lower than at any time since 1919.”

It is important to note that a “windfall profit tax” is merely another form of price control. Price caps and other forms of price regulation are no more effective in the 21st century than they were in the 1970s. Interference in market forces always creates inefficiencies in the marketplace and extra costs for consumers.

Volatility is the Issue
It is also important to keep in mind that the cost of gasoline is a significant but limited fraction of the average consumer's transportation budget, constituting less than 20 percent of vehicle-related expenditures. And although no one likes high gasoline prices, what is probably equally, if not more, irksome for consumers is gasoline price volatility. Unpredictable gasoline prices make it hard for consumers to incorporate the cost of gasoline into their transportation budgets.

Indeed, data from the Bureau of Labor statistics suggest that American consumers are quite adept at managing the various tradeoffs in their transportation budget. For example, according to the bureau, consumer expenditure data show differences in vehicle-related expenditures even for an average family of four vs. families of five or more. Families of five or more, for example, spent more on gasoline on an annual basis but spent less on vehicle purchases, maintenance and repair.

Consumers make these sorts of tradeoffs in an atmosphere of stable gasoline prices. In the face of disasters of the magnitude of a Katrina and Rita, there are few short-term fixes. However, in the long term, increased domestic refining capacity, coupled with increased regulatory and operational flexibility will promote greater price stability.

A Bad Idea
We do not support calls for the institution of a strategic gasoline or other refined product reserve. This concept has been discussed and studied on numerous occasions and, in each instance, rejected as unsound policy that would potentially disrupt the market. Filling a product reserve would attract supply from the already tight refined product market, thereby putting upward pressure on price. Any supplies diverted from the market would have to be replaced, most likely by imports.

Furthermore, complications arise both in storing refined products and in deciding which products to store. Gasoline, unlike crude oil, degrades over time and it would be necessary to refresh the stored product. The various fuel formulations in use throughout the nation - vital for states to use in meeting National Ambient Air Quality Standard obligations - raise the question of which type of fuel to store.

Other factors that would undoubtedly add complexity and uncertainty to an already complex and uncertain situation regarding strategic refined product storage include:

· The incorporation of the renewable fuels standards for both ethanol and bio-diesel prescribed by the Energy Policy Act of 2005
· The siting, permitting and construction of hundreds - perhaps thousands - of new aboveground storage tanks
· The problem of filling and maintaining the reserve while accommodating the current demand for refined products and the nation's need for imports

Additionally, the reserve would add pressure to both the refining and transportation infrastructure at a time when the nation's energy systems are strained. The reality is that actual supply shortages have not occurred on any great scale. Even in the aftermath of hurricanes Katrina and Rita, supply shortages were isolated and quickly remedied.

Finally, The California Energy Commission thoroughly investigated the efficacy of a refined product reserve and concluded: “The governor and legislature should not proceed with the strategic fuel reserve concept evaluated by the commission. … [A] strategic fuel reserve could have several unintended consequences, which could limit its effectiveness as a tool to moderate gasoline price spikes and could reduce the total supply of gasoline to the state.”

Our Recommendations
Domestic refining capacity is a scarce asset. There are currently 148 U.S. refineries owned by 54 companies in 33 states, with total crude oil processing capacity of roughly 17.1 million barrels per day. In 1981, there were 325 refineries in the United States with a capacity of 18.6 million barrels per day. While U.S. demand for gasoline has increased more than 20 percent in the last 20 years, U.S. refining capacity has decreased by 10 percent. No new refinery has been built in the United States since 1976, and it will be difficult to change this situation.

Increasing the nation's supply of oil, oil products and natural gas should be a No. 1 public policy priority. Now, and for many years in the past, increasing oil and gas supply has often been a secondary concern. Thus, oil and gas supply concerns have been secondary to whatever policy goal was more politically popular at the time. Enactment of the recent comprehensive Energy Bill is a first step to making the energy supply our nation depends upon a first priority of U.S. public policy.

Also, barriers to increased supplies of domestic oil and gas resources should be removed. Recent criticism about the concentration of America's energy infrastructure in the western Gulf is misplaced. Refineries and other important onshore facilities have been welcome in this area but not in many other parts of the country.

Policymakers have also restricted access to much-needed offshore oil and natural gas supplies in the eastern Gulf and off the shores of California and the East Coast. These areas must follow the example of Louisiana and many other states in sharing these energy resources with the rest of the nation because they are sorely needed.

Further, we need to resist tinkering with market forces when the supply/demand balance is tight. Market interference that may initially be politically popular leads to market inefficiencies and unnecessary costs. Policymakers must resist turning the clock backwards to the failed policies of the past. Experience with price constraints and allocation controls in the 1970s demonstrates the failure of price regulation, which adversely impacted both fuel supply and consumer cost.

Finally, the refining tax incentive provision in the Energy Act must be expanded. For example, reduce the depreciation period for refining investments from 10 to five years in order to remove a current disincentive for refining investment. Also, consider allowing expensing under the current language to take place as the investment is made, rather than when the equipment is actually placed in service.  E+P

Bob Slaughter is president of the National Petrochemical & Refiners Association. These comments were taken from his statement of Oct. 19 before the U.S. House Committee on Government Reform, Subcommittee on Energy and Resources. For more, visit www.npra.org.