Energy bills are a dime a dozen in Washington and many state capitals. They are the multipurpose solution reputedly solving every energy problem; they do everything from raising taxes for oil and gas companies, to subsidizing ethanol and plug-in hybrids, to threatening oil company executives with prison for “price gouging,” to promoting wind power (except, of course, when it might spoil Ted Kennedy’s sailing). Every gasoline price spike yields a cascade of proposed legislation and an outcry from politicians.

Politicians are right in suggesting that America faces certain serious energy problems, but they’ve misdiagnosed both the problems and the cure. America’s energy markets, including the infrastructure that makes trading in energy possible (made up of pipelines, oil and gas terminals, and refineries), are clogged with the debris of almost a hundred years of state and federal regulation. This “regulatory cholesterol” is as damaging to our economy as the “cholesterol” analogy suggests. Remaining within the analogy, the proposals that have been made by politicians are the equivalent of recommending that a heart patient in need of a triple bypass eat more steak instead of undergoing surgery. If we are going to meet our future energy needs, we need to unleash entrepreneurs on the problem. And that means politicians need to get out of the way, not add another layer of regulation. Regulatory Sclerosis Markets work best when they are broad and deep. Unfortunately in many energy markets, a combination of limited infrastructure and regulation limit the extent of the market. From the early twentieth century, both federal and state governments have been heavily involved in energy markets. John D. Rockefeller’s Standard Oil helped create a national market for petroleum-based fuels, both standardizing product quality (the inspiration for the company’s name) and building infrastructure like pipelines that broadened local markets into regional and national ones. The company also pioneered many of the innovations in refining technology that helped solve America’s first “energy crisis” in the early 1910s, when demand for gasoline outstripped production. Not surprisingly, this success was rewarded by a sustained assault by state and federal regulators on antitrust grounds, even as the company lost market share in an increasingly competitive market and gasoline prices fell – hardly the signs of a successful monopoly.

The pattern of government intervention was set by the Standard Oil case; energy companies were regularly attacked in the courts and legislatures, even as real fuel prices fell almost constantly, capital investment soared, and innovations in production technology increased production efficiency and fuel quality. When not attacking energy markets for providing too little competition, politicians assaulted them for providing too much. During the New Deal era, federal and state governments actively intervened in energy markets to limit competition. This reached beyond stifling regulatory proportions when, for instance, Texas and Oklahoma declared martial law in oil producing areas, and used troops to stop competitors from pumping “too much” oil. Ever since, each new batch of energy legislation has included provisions to protect favored interests from the ravages of “destructive competition” through special permits, exemptions, and tax breaks. Many states still have minimum pricing laws that prevent retailers from selling gasoline below a statutorily calculated “cost,” aimed at preventing efficient firms from selling fuel for less than inefficient ones.

With the vast expansion of regulation brought about by the environmental legislation of the 1970’s, regulators began to venture into even more areas of energy markets. Refinery and pipeline operations, expansions, and construction were now subject to extensive regulatory scrutiny. One result was a shift toward utilizing the refinery capacity overseas, and a reluctance to build new refineries domestically. No new refinery has been built in the United States since 1976, in part because the necessary permits can take years to acquire. Existing refineries have expanded capacity through massive capital investments, although the recent congressional ruckus and filing of lawsuits over Indiana’s grant of emissions permits to BP to allow expansion of the company’s Whiting, Indiana plant, may signal a more confrontational environment, even for expansions. Since the early 1990’s, EPA, states, and even local governments have increasingly required refiners to produce “boutique” fuels for specific markets, while also introducing new formulation requirements for fuels generally (e.g. ultra-low sulfur diesel requirements). Regulators impose these mandates in pursuit of a range of goals: reductions of auto and truck emissions, creation of markets for favored biofuel mixes, and protection of sensitive pollution control devices on cars and trucks from contaminants in fuels.

Laudable as these goals may be, the cumulative impact of the formulation requirements is to fragment the market for transportation fuels. As a result, many regional markets can be supplied only by a small number of refineries, limiting competition, as well as diverting capital investments to equipment needed to meet regulatory needs (and therefore away from improving capacity). Price spikes can also occur when one of the few refineries in a particular market closes for maintenance, or because of an accident. Several recent economic studies have found price effects from these regulations. Restoring Our Energy Markets to Health

A straightforward cure for the regulatory sclerosis afflicting our energy markets is simply this: we must get the government out of the way. Repealing state minimum pricing laws and ending talk of windfall profits taxes, price gouging legislation, and other disincentives would encourage innovative players to enter energy markets. The refining business was revolutionized as companies like Valero entered it, bringing new, efficient multi-refinery management techniques to bear that increased capacity. Privately-held Koch Industries has introduced CEO Charles Koch’s innovative market-based management techniques to the industry. Some supermarket chains and retail giant Wal-Mart have started selling fuel as a technique to draw customers to their main businesses, a tactic sometimes blocked by minimum price laws.

To take just one example of the benefits possible for consumers, imagine the results of unleashing Wal-Mart’s price-cutting inventory and supply chain management techniques on the gasoline market. Regulatory barriers to entry to refinery construction and expansion could be significantly lowered without endangering environmental protection goals by replacing the patchwork quilt of regulations with stream-lined, one-stop shop reviews.

On the rare occasions when energy markets have been allowed to work relatively unimpeded by political efforts to serve special interests, market forces and private enterprise have delivered dramatic improvements in energy. Competition, not government tax breaks, drove the “octane race” of 1930’s that boosted gasoline quality. Market forces, not government regulations, led some U.S. oil companies to lead the world in the development of the tanker fleets, oil terminals, and exploration rights around the world that brought America falling energy prices throughout the 1950’s and fueled the post-World War II boom in automobile travel. Companies seeking an advantage in sales, not bureaucrats, drove the development of retail innovations, from clean service station restrooms, to today’s pay-at-the-pump technology. Improved blends of gasoline for high altitudes and cold weather came from entrepreneurs, not regulators. If we unleash the power of markets and entrepreneurs on our energy problems, American consumers can count on economical, safe, and reliable energy supplies. If we let politicians in Washington and state capitols force feed our energy markets more “regulatory cholesterol,” we face a future of rising energy prices, shortages, and an increasingly unreliable infrastructure.

– Andrew P. Morriss is H. Ross & Helen Workman Professor of Law and Business and professor of the Institute for Government and Public Affairs at the University of Illinois, and a senior fellow at the Institute for Energy Research, Houston, Tex. His book on gasoline markets is forthcoming from Yale University Press in 2009.