This week the Energy Information Agency (EIA) released findings in their “Today in Energy” blog, revealing that 2012 global oil production reached a record high. Earlier this year, on the very same blog, the EIA released information showing that 2012 also saw record high oil prices. This may come as a shock to many people who might believe that drilling more oil will decrease prices, but the facts clearly show that record levels of oil drilling coincide with record levels of oil prices.
This fallacy may stem from applying to the oil market the common rules of supply and demand that guide pricing principles in competitive markets. Given our lack of alternative transportation fuels, oil does not operate in a competitive market. Rather, the monopolistic environment of oil markets creates conditions that enable higher prices which, among other things, lead to higher production levels.
In a truly competitive market, the price of a good is set by the cost of the cheapest unit of the good brought to market. Oil prices, operating in a monopolistic market, are set more closely to the cost of the most expensive unit (barrel) brought to market. This is because, in a competitive market, if one supplier’s goods are priced higher than his competitors’ goods, consumers would opt for the cheaper good. Thus, in a competitive market, the most efficient supplier who can bring the product to market at the cheapest price is rewarded.
With oil, however, if a given supplier has significantly less expenses than his competitors and could bring his product to market at a cheaper price, he would be foregoing profits by doing so because his oil would be bought at the higher price. The main reason for this is that most of the world’s drivers have no option for fueling their car beyond gasoline or diesel; both are fuels refined from oil. Hence, the existence of a monopolistic market.
No company likely would, or perhaps even should, intentionally forego profits. Therefore, we cannot in good conscience blame any given oil company for selling us oil at a high price. The only way to force the price down is to transform the transportation fuel market (since oil’s primary use is as a transportation fuel) into a competitive market.
Breaking this monopoly can be achieved by enabling drivers to choose between fuels when filling up their gas tanks. Cars like the Chevy Volt, which can run on either electricity or gasoline, are an example of how consumer choice with regards to fuel can save drivers money. Other fuels such as ethanol and methanol can also be used to expand consumer choice, with a significantly smaller capital investment, by making slight modifications to existing vehicles to facilitate the safe and efficient use of these fuels. Lastly, unlike gasoline and diesel, which are only produced from oil, ethanol, methanol and electricity can all be produced from multiple sources, further increasing consumer choice and hence competition.