Saturday, October 22, 2005

This Just in: Free Markets Work

Good thing the Hawaiian Public Utilities Commission doesn’t run the U.S. government.

In August, that body decided to cap gasoline prices in Hawaii—where gasoline prices are the highest in the country, as one might expect given the fact that everything else in Hawaii costs more than on the mainland—to teach those nasty, price-gouging oil companies a lesson in the wake of hurricane-related price spike.

Such a gas cap sounds like a good idea, I suppose, unless you were around in the 1970’s, when the U.S. government decided to cap prices on crude oil in the United States and helped create a long-term oil crisis that didn’t get resolved until Jimmy Carter signed the law deregulating crude oil prices.

Carter did the right thing: by freeing oil prices to market-clearing levels, he exposed U.S. consumers to the fact that oil prices had gone up—which, naturally, caused consumers to implement all sorts of energy-savings techniques. He also, however, unleashed a short-term inflationary spiral resulting in the ultra-high interest rate policy of Fed Chairman Paul Volcker designed to crush that inflation.

Energy demand fell and so did oil prices, which in time set the stage for a disinflationary economic environment that triggered one of the greatest bull markets of all time.

Unfortunately for Jimmy Carter, he was not around to see the great bull market, because American consumers had voted him out of office owing to the inflationary spiral and the interest rate spike triggered by his decontrol of oil prices.

Like Richard Nixon’s wage and price controls back in the 1970’s, the 2005 Hawaiian PUC’s response to the hurricane-inflicted oil supply disruptions was sorely misguided, as proven by the recent price trend at my local Gulf Station.

After hitting highs around $3.25 a gallon for unleaded regular a month or so ago, the price at the Gulf Station has been falling steadily. More recently it's dropped like a rock: just yesterday it was down a dime, from $2.67 a gallon to $2.57, overnight.

Seems rising gasoline and deisel and jet fuel prices caused total oil product demand in the U.S. to fall more than 3% year-over-year in the last month, reversing a steady upward climb over the last decade that helped put us in the position whereby world oil supply was barely keeping up with demand.

Combine that demand reduction with the surge in supplies shipped over from Rotterdam and elsewhere to make up for the lost hurricane-related supply; and you get lower prices at the Gulf Station in New England.

Now, $2.57 a gallon is still up 20% from last year—and U.S. consumers are still not out of the woods.

But they’re a lot better off than the dark post-hurricane days when the folks in Hawaii decided to do something about the free market price of gasoline.

Jeff Matthews
I Am Not Making This Up

© 2005 Jeff Matthews

The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations.


Its_strange said...

Well that 75 cent drop in gas is great news but if PMI Groups view that home prices are on the way down turns out to be right that drop in gas ain't going to help much....Free Markets work and that also means pain. Kinda like life in general

WallStreet1978 said...

Jeff, I could not agree with you more. The People's Republic of Hawaii made a serious mistake. I often wonder why politicians and even business people say they are for free markets and capitalism when it is working in their favor, however, the moment something starts moving in a direction that isn't to their liking they want to establish price controls or other brash policies. I think that if we finally got serious and allowed the markets to operate freely life would be even better than it is today.

henry murfey said...

Dear Mr. Mathews,

At age 72, my memory may not be what it used to be. However, I believe that Ronald Reagan signed an executive order in the spring of 1981 which killed the Carter controls. Wall St., naturally, thought prices would be hung on sky hooks. Crude's rally to over $40 per barrel was soon squelched, and the rest is economic history.

As for Paul Volker, his monetary policy produced a "stop then go" result in the growth of the money supply during 1980. Next, his failure to permit money supply growth in the first half of 1982 prolonged economic slowing
As a consequence, Reagan lost the working majority which he'd gotten in the Congress, thus allowing the statists to block free market reforms until after the 1984 elections.

Carter should have found house building before politics. Volker's reputation is high with the NYC based bankers and the Manhattan PR world. For those of us who had to react to his mal conceived policies, we'll put him shoulder to shoulder with G. William Miller.

P.S. I wouldn't miss your thoughts (to the extent that dial up service allows.)

A. Saxena said...


Maybe I am missing something. What was the result of Hawaii capping prices? Is there an oil crisis in Hawaii?


Oldnative said...

Just for clarification, the PUC didn't put the cap in place, it was the local (or is it loco) legislature did. One of the byproducts is that consumers are gaming the system since they know the direction of the weekly cap (there's a lag vs. the market). If they know prices will come down, they defer purchases, sticking the station owners with higher cost inventory that must be worked off before new, lower-cost inventory can be acquired from wholesalers. Conversely, in times of rising prices, demand escallates before the change in the cap, sometimes resulting in stations running out of gas. Never trust a politician to get things right.

Jeff Matthews said...

"Oldnative": I greatly appreciate the first-hand account of the impact of the Hawaiian price caps.

While the caps have not caused a "crisis"...they did nothing to alleviate the oil spike which the market itself wouldn't have done.

"Henry Murfey": You are correct that Ronald Reagan eliminated the oil and gas price controls--but he merely accelerated the decontrol program Carter had put into place and eliminated the 'windfall profits tax'.

Those wage and price controls had been established by Richard Nixon, as you would recall--not Jimmy Carter. I was working in Washington the summer Carter was pushing the decontrol legislation through, and it was very difficult for him to convince his own party to support it.

To his credit--whatever else you think of him--Carter set into motion the dismantling of Nixon's price controls. Ironic that Reagan gets credit for it, but history is written by the winners.

Paul Volcker, well, agreed.

Thanks for your kind comments!

A. Saxena said...


Thanks for the clarification.

"Oldnative", perhaps some of the consumers are gaming the system. I would imagine some of the gas station owners are doing the same to the extent they can.

There is a well-known concept of prices shooting up like a rocket, but coming down like a feather. In the rest of the states this concept is in full effect. Sometimes, free markets work this way.

Anybody gaming a system generally does better than somebody who is not. Those who have rented an apartment in NYC certainly know the price they have paid so others could live in reduced rent apartments right next to them. And, if you haven't lived in NYC, you have probably had some experience filing your tax returns.

Anybody willing to give the politicians a paid holiday?


Serkan said...

What Gulf station are you going to? I haven't seen 2.57 in Fairfield county in months. To my knowledge, the cheapest gas is still on the Merrit, which I visit on the way to Westport.

As an aside, can someone explain to the mainstream financial press that tight refinery capacity DOES NOT MOVE OIL PRICES HIGHER. I am so tired of seeing that headline because it doesn't make sense.

Now I'm going to nitpick a little. Your statement here also doesn't really make sense:
"Energy demand fell and so did oil prices, which in time set the stage for a disinflationary economic environment that triggered one of the greatest bull markets of all time." Falling oil prices do not a productivity boom create.

And finally, it's pretty clear that weather has a lot to do with the year to year wiggles in oil consumption. It's tough to imagine people were able to cut their energy usage by 3% in a few months by sheer will. I think it's a little early to start ringing the elasticity bell.