The price of gasoline has risen more than a dollar in the past month and I couldn’t be happier. Why? Well, there simply isn’t enough gas to go around right now. That may be hard to believe, but it’s true. The nation’s refineries cannot produce enough gasoline to keep up with the American drivers. Prior to Hurricane Katrina, American refineries were operating at 97% capacity, processing 17 million barrels of oil a day (American consumes 20.6 million barrels of oil a day.) (Hat tip to Hugh Hewitt.) Katrina knocked out 10% of that refining capacity. That means Americans want to consume 20.6 million barrels a day and the refineries can only produce 15.3 million barrels a day. Obviously, consumption needs to come down. Only two things will cause people to use less gas: government rationing or high prices.

In the interests of brevity and clarity, I’ll refrain from spelling out why government rationing would be a bad thing. The short answer is: 1970′s style gas lines. If you want to hear the long answer, leave a comment or send an e-mail and I’ll be happy to break it down. But for now, I’ll assume that most people understand why government rationing would be a bad thing.

I prefer the simplicity of higher gas prices instead of government mandated price ceilings or rationing. High prices will regulate consumption far better than any government bureaucrat ever could. Each price increase will increase the cost to drive one mile. Many people argue that driving is a necessary activity, that people will drive the same amount no matter what gasoline costs. I think that’s a somewhat limited view. There is a certain amount of driving I need to do. I need to drive to and from the office, 5 days a week. I need to attend church once a week. I need to go grocery shopping at least twice a month. What about seeing a movie, visiting Milwaukee, or driving out to Quaker Steak & Lube for dinner? Well, that depends on what the price of gas is. I didn’t change my driving habits when gasoline was $2.50 a gallon. I am changing my driving habits now that gas is $3.25 a gallon. Once gasoline hits $4.00 a gallon, I will only do whatever driving is absolutely necessary.

Everyone changes their driving at a different price. When I was in high-school (on a limited budget) I would drive less if gasoline went from $1.00 a gallon to $1.10 a gallon. Now that I’m out of college and I have a full time job, I can afford to drive on gas that costs $2.69 a gallon. My point is this: some customers are more sensitive to price than others. Some driving is necessary, some is not. High prices will force people to drive less. The real question is: what price will force an individual to drive the absolute minimum necessary? Eventually, everyone will hit their limit and people will only drive when it is necessary. I think gasoline that costs $3.25 or $4.00 per gallon will do that, but I could be wrong.

Ultimately, the price of gasoline will continue to rise until Americans are only consuming 15.3 million barrels of oil per day. The nationwide consumption of gasoline will match the nationwide production of gasoline, and it will happen without one government official having to lift a finger. Along the way, many people will accuse gas station owners of “price gouging”. I think this accusation is a little unfair. The retailers are only charging what is necessary to replenish their supply. As Shannon Love said earlier today:

Most people think that the “fair” price for the gas they buy is the wholesale price of the gas the station has already purchased plus a reasonable markup for profit. If this was actually how the stations set prices then watching the stations raise prices on gasoline already in their storage tanks would be an obvious sign [of] price gouging. The price differential between price the station paid and the new higher price would be a windfall profit.

However, the price of a gallon of gas you buy doesn’t reflect the cost that particular gallon but rather the expected cost of the gallon of gas the station will have to buy to replace it. As the expected replacement price soars, so does the cost to the customer for the gas already in stations tanks because that is where the station is getting the money to buy the replacement fuel. The station can only get a windfall if the the cost of replacement gas drops suddenly. Until that happens, its like bailing a leaky boat to stay ahead of rising cost. It might look like price gouging when the local station raises prices three times in one day but what they are doing is following the futures price for the gas they will have to buy tomorrow.

I suppose someone could accuse the wholesalers of price gouging, but I think that’s also unfair. Wholesalers face two unpleasant choices: keep the price of gas low and have more demand than they can fulfill. That choice will eventually lead to gasoline shortages: approximately 5 million barrels per day short. Or they can send the refined gasoline to whichever region is willing to pay the most for it. That will ensure that the people that need the fuel most desperately can get it. As a side benefit, it will reduce the demand for gasoline and ensure that gas stations won’t be left with empty pumps.

Give me high prices, as high as are needed. As long as prices are set by the people in the market, I can stop at a gas station confident that there will be gas for me to buy. While expensive gasoline is a pain in the neck, it’s far better than facing shortages and long gas lines. I think most people would agree that they have better uses for their time than waiting in gas lines — especially if you work for an hourly wage. Better to pay a $1 more per gallon than to miss 5 hours of work waiting for the next delivery of cheap gas. So please, leave the prices high and let the free market do it’s thing.

(Shortly after I finished writing this, but well before I published it, I discovered this post by Megan McArdle making the same point. Ah, well. I don’t think it’s possible to have too much economic education in the world.)