The Unbroken Window

On August 7th , British Petroleum, the world’s 2nd largest oil company discovered corrosion in the pipelines at its Prudhoe Bay oil field - prompting it to shut down and repair 16 miles of pipeline. The shutdown is expected to disrupt oil supplies to the United States by as much as 400,000 barrels per day for several months.

This “crisis” has prompted many to resume their blame game on the oil companies for higher gasoline prices. Notwithstanding the fact that this disruption is expected to have a small effect, if any, on gasoline prices, this is an excellent opportunity to demonstrate two salient features about oil prices - and business operation in general. First, the real world is characterized by varying amounts of risk. Businesses can be disrupted, damaged or destroyed by floods, hurricanes, ice storms and more. When they do, the price system is the most efficient and equitable way for “society” to respond. During events such as a shutdown of a pipeline, the prices of scarce goods rises - signaling to consumers to economize on usage of the good (and /or find substitutes) and signaling to producers to increase and reallocate output so as to alleviate the problem. Second, government regulation that interferes with the price mechanism and alters the incentives of producers and consumers will amplify any problem that they are attempting to rectify.

Special favors granted on the oil industry by the federal government are partly responsible for the BP “crisis.” The result of these favors is that oil companies have fewer incentives to care for their property - and shift their time horizons forward to caring about short-term profits over long-term stewardship.

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