[saymaListserv] [afmdiscussion] Ken Spitze Column for May 14: "Economics 101: How (not) to Lower Gas Prices

Julia Ewen jewen at bellsouth.net
Mon May 22 18:50:03 JEST 2006

Janet wrote in part:

>>One of the versions of this "strategy" claims that if we all refuse 
to buy from ExxonMobil, they would be forced to lower their gas price 
and all other companies would be forced to follow suit. This scheme 
was so convincing that the Bee County, Texas County Commission 
actually passed a resolution urging citizens to boycott ExxonMobil stations.

This is absolutely right! And your other exampes are too, Janet. 

ExxonMobile was the focus
of most of the ones I saw because of a belief that ExxonMobile distributed most of the oil that came out of the Middle East or had the biggest percent of its oil coming out of the Middle East, and therefore if we wanted to discourage war for oil in the Middle East we should boycott ExxonMobile. This is also a pointless strategy. 

As Janet pointed out in her essay, the oil companies buy and sell among themselves so much, and so do the speculators, that by the time it gets to us, it is anybody's guess as to where your particular gallon of gas originated in the world. And even if that were not so, there are a limited number of refineries and pipelines, where the oil sources are co-mingled in the refining and distribution. Much of what comes through the pipeline to Atlanta, even, is co-mingled, and the oil companies load it into trucks painted different colors--but all of it has oil in it from the Middle East.

And what we do at the pump impacts far more directly on the station operator than on the oil companies, which have a lot of other customers elsewhere in the world. China and India and Koren will be glad to slurp up whatever we don't buy. Whereas the station operator gets about 10 cents out of every gallon of gas we buy, and it matters to him whether he gets that dime or the station on the other corner. 

The station owners have to make an exclusive contractual deal with a particular oil company, and it is not all that easy to turn yourself from an Exxon outlet into,say a BP outlet. You certainly can't do it every time there's a price advantage with a competing oil company. It is rather like the college campus food concession, not like the food court at the mall!!

(Independent operators used to have some flexibility about suppliers, but the big oil companies have largely succeeded in running them out of business. Today your gas station operator likely either owns a franchise from an oil company or runs a station owned directly by the oil company.  If he does not post prices as ordered by the company, he may find himself short on his next delivery...much as he want your dime, he cannot sell you gasoline that he does not have. Meanwhile the guy across the street is taking his business. And some customers never come back. If you were him, who would you want to please most...???)

There are basically two factors currently driving the price of oil at the pump that IMHO have rather more impact than the price at the well head:

(1) refining capacity and costs
(2) speculation on the commodities market

There is not at present a world  or USA shortage of crude oil! The disruptions of war have some effect on supplies,( but mostly on the commodities market)  Prior to our invasion of Iraq, we were getting only a trickle of crude oil from Iraq anyway--it was under sanctions, and the "oil for food" program was barely oozing crude out of Iraq. Venezuela's President  cut USA oil companies back. But Venzuela alone does not hold a "swing vote" in the market setting of prices...It is not the supply of crude that is the problem! Nor even entirely the demand at the pump!

At the outset of the war I saw a press release from the Saudis saying that they were still pumping at pre-war rates and willing to pump more. But they said that was not the problem. The US refineries were unable to handle more, even if they did pump it. They asserted they had offered to help by investing money in refineries in their own country--and here in the USA--but they had been turned down in regard to financing more  American refineries! We also saw that in the Gulf Coast hurricane disatsters that refineries and pipelines being taken off-line were the cause of drastic dislocations in the market. 

With demand so high and climbing, why, if market forces are operating freely, would the oil companies not want to modernize or build new refineries? Because that requires a substantial outlay of cash, which the profit margin of the refinery operation would not pay back for many years. Refining is the highest cost-lowest profit component of the industry.  Most of the difference between the price of crude straight out of the ground and your gallon of gas are in the refining and distribution and marketing, under normal conditions. 

This brings us to factor (2) speculation.

If you know how the stock market works, you can understand how speculation works: when people buy and sell stock, the actual paper is not often handed back and forth. Trades between buyers and seller are recorded at a central clearing center called the "stock exchange". There is a similar market in Chicago for commodities. Current  oil stock is bought and sold there (the actual barrel of oil  is not delivered to the speculator. He gets rid of the paper before the product delivery date!) 

What really drives speculation is the buying and selling of "futures"--contracts for delivery of oil that has not yet even been pumped out of the ground. It is a gambling game. The buyer of a "future" contract hopes that hehas puchased the oil for less than its market value will be at the time it is being pumped and sent to market. The seller hopes that the price he has been paid today will be better than the price he could get if he sold it the day it is pumped out of the ground. The prices of these futures affect the oil that is sitting around in inventory awaiting processing and delivery to the gas pumps. 

What your gas station operator pays is not the actual value of the barrel of oil that your gallon of gas came from. It is based on the very highly speculative price of the NEXT gallon of gas he will have to buy to replace the galon that he just sold to you. During the gasoline crisis under Carter in the 1970's emergency measures were taken to require the station operator to base his price on his last delivery, not on his next. Those regulations expired a number of years ago. Perhaps they should be brought back. It might help. If coupled with less actual usage, prices would tend to be a bit more stable and speculation would be a little less attractive.

As it is, the wide swings in prices on the futures market make it one of the hottest spots for people with lots of cash.
And the big bull market in stocks has both corporations and individual stock owners awash in it! With stocks cooling, and bond yields not all that hot, commodities--and oil in particular--look attractive to people who know that they are doing. Which is NOT MANY OF US! The more people buy and sell in this "imaginary" realm of nonexistent (at present) barrells of oil, the higher the replacement price on your gallon of gas goes for your gas station operator. 

The speculative price of the futures also benefits the oil companies because their inventories and their contracts for pumping oil are things that the corporations could sell to raise cash. They are good collateral for bank loans. They form part of their corporate worth.  Even if their profit margins were not growing, the rise in the values of their inventories and  of their contracts strengthen their creditworthiness among their bankers. The cost of getting cash loans (which all companies need to some degree or other) and selling their corporation's bonds on the securities market are more favorable with a high corporate worth. Their corporate stock tends to rise on the stock market, and their investors are happy, even if the profits, from which dividends are paid, did not rise more quickly than they are.  

And there is no cash outlay involved!! Unlike building or renovating refineries and expanding delivery systems. Which they would have to do to make this much income on a much lower price per gallon (they would have to refine and move much higher volume of the processed products).

With prices as high as they are, oil fields that were once unprofitable to exploit should be profitable to tap now. Exploration subsidies should not be necessary. But what has happened? The oil companies are fighting proposals to roll back tax breaks and incentives. They are claiming that they need PUBLIC MONEY on top of all these profits to induce them to find and pump new oil if prices are to come down.Then when asked why they haven't found new oil and started pumping it, what will they say? Oh, we know where the oil is, but there's no point in pumping it because the refinery capacity is already maxed. And where will that public money go? Into the corporate worth. It becomes part of their income statements and balance sheets, which help them look better to bankers and the securities market ......

What's needed is to break the stranglehold that oil has on us. Americans won't be going to go back to 19th century Amish style living in massive numbers. What's needed is widespread availability of alternative fuels, such as methane and ethanol (and electric vehicles with better accelleration and range) and inexpensive ways to adapt vehicles presently on the road to burn the new fuels. Not everybody can afford to spend $20,000 and up to replace our gas-buggies. But many of us would gladly spend a few hundred or even a couple of thousand adapting our vehicles if we can't afford an entire new non-oil burning one. That is where government subsidies should be going. 

Now you may know far more than you ever wanted to know about why your gasoline is high as a cat's back.

Janet is absolutely right! The ONLY way to make the prices go down is to not buy gasoline. And if buying something else becomes practical, when the price of gasoline does come down, will American drivers care? 

But consumption at the pump is only a sideshow, not the main event in oil pricing. If the oil companies simply switch their methods to price abuse of the alternative fuels, we will be doing the same dance. The raw materials for methane and ethanol are not "scarce" as oil. But the issues regarding refining and forward pricing and commodities market speculation will still be there. In focusing on the gasoline pump, IMHO we are not focusing on the real problem--which is that the fuel companies not only are paying the piper and calling the tune--they and the speculators are the only ones invited to the dance! 


For what it's worth.


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