Here we go again! Having just witnessed the biggest whiplash in gasoline prices in my 30 year career, I knew it was coming. As gasoline prices rose over $1.50/gal (yes, you read that right!) last month, the cries from the politicians echoed through the media. I've attached one such rant from the Chairman of the California Energy Commission for your review. In summary, he hints at using (much like Putin) all means at his disposal to root out the big oil company conspiracy to raise prices and gouge consumers. The second attachment is from Phillips 66 announcing the closure of their refinery in Santa Maria, CA. What could one possibly have to do with the other??
Let's first deal with the issue of rising prices. If you've followed this blog at all, you know that prices are, and forever will be, determined by supply and demand. In addition, I've talked about the "inelasticity" of the demand for fuel. In a nutshell, this means that the demand for fuel (both gasoline and diesel), is very "steep", and increases in price have very little effect on the quantity of the fuel demanded. What this translates to at the pump is that small supply disruptions can have dramatic effects on prices. Mr Hochschild, with the California Energy Commission, implies that it's not supply and demand but, as per usual, a conspiracy by major oil to gouge consumers. Could it be a conspiracy?
If history is any lesson at all, the answer to my previous question is no. I've heard this argument for over 30 years! Everytime the price of gasoline goes up, the politicians are on the front page calling for the heads of major oil. They call for an "investigation" and put together "action committees" to look into it. In addition, I personally get calls from local media outlets asking me to comment. My wife always laughs upon seeing the interviews and says that I "always say the same thing." Basic Econ never changes folks, and then weeks, or months later, on the back page you'll find an article as to how the "select committee on fuel price gouging" found no evidence of price fixing. Think on this for a minute. If you were a major oil company CEO, and the State of California has been insinuating that you've been colluding with other oil companies for over 30 years, would you still collude anyway?? Only if you're the biggest idiot on the planet! Not only that, economic theory surrounding game theory would also indicate otherwise. Without getting too deep into game theory, which I love by the way, it concludes that even a small number of players when trying to collude will "cheat" on any agreement in order to reap additional profits for themselves. OPEC is a perfect example. They have these big meetings, and agree to cut output in order to raise prices, and inevitably price goes up by less that anticipated. Why? They all go home and produce more that they agreed to, thereby lessening the effect of the supply cut. Don't get me wrong, "Big Oil" has a past full of wrongs; however, in this case I don't think they are at fault. On a more anecdotal note, I've personally met many of the individuals that control the pricing at the major oil companies. They are rivals, and there's no "love loss" between them. The idea that these guys are texting each other with price moves, and colluding, flies in the face of their competitive nature.
If Big Oil is not "price gouging," then they are also not to "blame" for "excessive profits." The two go hand in hand in the oil business. In my past posts, I've explained and predicted, how rising prices for fuels will naturally lead to increased profits. This again has to do with the "inelasticity" of the demand for fuels. I won't prove it again here, but oil companies profits are rising not because of greed, per se, but due to economics! Politicians continue to live as if the transition to green energy is complete, when we are in fact far from it. Major Oil has a lock on a commodity which we still crave, and can you really blame them for thumbing their noses at the politicians when prices and profits rise? That's probably what's going on behind closed doors, not collusion, but laughter at the politicians in charge. On another note, who is Gov Newsom to determine how much profit a company should make? Now it's Big Oil, but who's next? Amazon, Walmart? Now, throw in exhibit number two from Phillips 66, and everything makes even more sense.
Phillips 66 announces that they are not only closing their Santa Maria refinery, but tearing it down and remediating the "sand" it sits on. Econ 101: Do you think that will help, or hurt gasoline prices? Perhaps a little more information is needed. Last time I checked, California has around 14 or so refineries (that number has fallen by 3 since 2017), so the loss of another one is significant. Back to Econ 101: if supply shifts left along an "inelastic" demand curve prices will rise, and the increase could be dramatic. Let's consider Phillips 66 again. With the recent calls to stop gouging and lower prices, how do you think the 70+ employees losing their jobs at the Santa Maria refinery will respond to increasing production so prices can fall? As Phillips 66 gets ready to transition their rodeo refinery to renewable diesel, how do you think they will respond to increased calls for gasoline? This isn't rocket science folks! Both of these actions have reduced the supply of gasoline in the state, and future price swings will be even more pronounced. Mr Hochschild seems to imply that since past refinery issues only lead to price increases in the 50 cent range, that the current price swing of $1.50 is rooted in collusion. This violates a basic tenant of economics: "ceteris paribus," or "everything being constant". Everything is not constant in the California fuel model. Refineries are closing, and/or transitioning to other "green" fuels which makes the supply of gasoline highly volatile. If my economic analysis is correct more volatility is on the way.
I was about to post this when gasoline prices suddenly fell, within 48 hours, almost $1/gal. Hmmm, did the politicians calls for a "profit gouging tax" have the intended consequences? Me thinks so, because diesel started moving in the opposite direction! This illustrates another basic tenant of economics: "there's not such thing as a free lunch." I can't back this up with data in this particular instance, as the market is so fluid, but I think the refineries shifted production from diesel to gasoline! If less diesel is produced, diesel prices rise, and the increased gasoline production causes gas prices to fall. Consumers and politicians will be happier as gasoline falls, but this is an illusion. At the same time gas fell $1/gal, diesel rose 50 cents/gal (this anomaly almost never happens -- gas and diesel tend to move in the same direction). I sell much more diesel than gasoline, and higher diesel prices affect truckers and farmers. Therefore, these increased diesel costs will eventually show up in everything you buy on Amazon, every item you buy at the supermarket, etc., etc. However, the intended political consequences have been achieved: Newsom can say he lowered gas prices, and by the way is sending out checks, as we speak, to help with your fuel bill. But, oh, please ignore your grocery bill! Retirement is sounding better every day...
Hey everyone, one of my readers pointed out that gas and diesel prices moving in the opposite direction would be very rare. He's absolutely right. I believe the refineries ramped up gasoline production at the expense of diesel. This causes gas prices to fall, but diesel prices to rise. This saves face politically after Big Oil having been lambasted in the press recently. No data to prove my point, but this would logically explain the pricing anomaly.
Hey Scott- Good to hear from you again. Sorry you had to spend your sunday morning on this. Hope you and yours are doing well. Thought I would throw a graph your way...got this stuff from the CEC
The refinery issue makes good sense...but dang that curve is steep. That's all market volatility?
Cheers,
Craig