Oil Logic

Even the most pragmatic and sensible people seem to lose their moorings when the subject turns to the price of gas and oil. A review of some basic principles is in order.

All companies have a need to raise capital, even if it’s infrequently.

Capitalists will provide capital only if they expect to be rewarded for the risk they take. This means that more profitable companies have a lower cost of capital (all other things being equal – other factors certainly contribute to the calculation).

If you make a company less profitable by government policy, the company must find a way to stay profitable enough to attract capital. For commodity producers, such as big oil, this usually means raising prices. If you reduce profitability for an entire industry, the entire industry must raise prices.

I generally favor reduced government interference in markets. But I also favor gradual change, otherwise rational planning isn’t possible. So, if we were to reduce oil subsidies (say by changing the oil depletion allowance) or create a windfall profit tax, we should do it slowly over the course of years. But regardless of how we do it, it will either push the price of gasoline at the pump upwards or create shortages. It can’t work any other way.


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