Unintended Consequences

by Steven Lord, Trend Investor

The Law of Unintended Consequences is one of the most consistent in the human experience. It ranges from the Treaty of Versailles effectively causing World War II to burglars suing their victims if they slip and fall on the stairs while robbing the house. And while there are examples of positive outcomes, they are almost universally negative.

Politicians seem particularly adept at falling prey to the Law, especially when they attempt to “fix” something either not broken or usually left to society at large, the economy, markets, etc. I saw this sort of thing firsthand in Germany years ago, where the vast German social net paid unemployed workers so well that the incentive to get off their duffs to get a job was completely removed. Hence, the unemployment rate was high, in spite of the best intentions of Germany’s social engineers.

Lately, our new Congress seems eager to test the Law as quickly as possible. First, they passed a large hike in the minimum wage, which in the past has led to the interesting result of actually increasing unemployment among society’s poorest workers. Then yesterday, the House of Representatives voted to roll back $14 billion in tax credits for oil drillers. While it plays well to an electorate eager to “get back at” the big oil companies, the step is disingenuous.

Why? Because the unintended consequence will be more expensive gas down the road. These are the same Democrats who constantly rail against foreign dependence on oil, lack of alternative energy, etc. and are convinced George Bush has made a side deal with energy companies to stick to the American people. So their response? Make U.S. offshore drilling more expensive for U.S. companies.

Exploration tax breaks were given to oil companies back in 2003 as an incentive to get out there and find more U.S.-based oil. It was a carrot to induce them to embark on extraordinarily expensive exploration programs and reduce U.S. dependence on foreign sources of energy. That was a sound plan: Oil companies are profit-making enterprises and the risk of exploration programs coming up empty is large, so making it easier for them to swallow the risk is sound policy; making these same companies pay through the nose simply because you can is not.

As for plans to use the “revenue” squeezed from Big Oil to fund alternative energy projects, it is safe to say that innovation has never been the government’s strong suit. Over and over again, we have seen that sort of thing better left to entrepreneurs with a profit incentive. Plus, creating an alternative energy slush fund, controlled by Democrats with agendas and force-funded by those big evil oil companies, invites exactly the kind of corruption and misdealing we’ve seen in Congress for years.

And while laudable, even a full-out national effort for alternative energy wouldn’t get us to work tomorrow morning. Right now, cars don’t run on wind. Finding and securing additional U.S.-based oil supplies should clearly be the tactical goal of energy policy, not finding ways to “punish” oil firms because the price of their base commodity has risen.

The ultimate irony? The House bill passed the same day crude oil fell below $50 for the first time in nearly two years. Oil companies are getting squeezed all on their own, via the normal market-based action of supply and demand. They all ramped up production and exploration when oil was $70 and now face getting 20% less for their product.

Ultimately, oil companies will simply pass these additional costs onto consumers. They will consider curtailing exploration efforts to ensure their margins. These steps bring the whole thing full circle, resulting in higher prices at the pump and reduced U.S. energy independence. In other words, the polar opposite of what Congress intended.