Gasoline Price Conspiracy!

GASOLINE PRICE CONSPIRACY!

Every couple of years or so, the price of gasoline in the U.S. soars, and people complain about how unfair it is, how the oil companies are just ripping us off, and how the government needs to do something. But the sad reality is that most Americans are embarrassingly ignorant about what’s really behind the higher oil and gas prices, and almost all of what they “know” about the topic is wrong or at least woefully incomplete.
So here we are again, in early-2012, with gas prices soaring and the media happy to broadcast people declaring things like “When they feel like they want to make more money, they up the price!” (ABC World News, 2/22/2012) Of course – it’s just not that simple.
Back in 2007, things were even worse than now, so I took a careful look at what was really behind skyrocketing gas prices. Five years later, the story is basically the same (but with Iran instead of Nigeria + Venezuela; $107 oil vs. $70 oil), so what follows still pretty well explains what’s going on. It’s a long, complicated story though, so if you just want to cut to the chase, you can scroll down to the Conclusions on the last few pages. As with some of my other essays, this one has a lot of graphics that don’t show up correctly here; if you want the whole story, just email me for a Word copy of the essay. But anyway, here’s what I wrote back then:
It is widely accepted in this country that:

1) Oil prices are manipulated by major oil companies,

2) Federal and state governments are complicit in this manipulation

3) Nationwide gasoline prices are unjustifiably high because of a joint oil company/government conspiracy

4) With Republican administrations, gasoline prices fall before elections and rise right after them, in order to win elections and maximize oil company profits

5) California gasoline prices are exceptionally high because of a conspiracy of the seven major oil companies.

Regarding the fourth “truism”, David Goldstein of aptly-named horsesAss.org typifies the conventional wisdom when saying in January of this year: “High gas prices were an affront and a hardship that voters angrily faced every day, and so it was with some suspicion that I watched gas prices inexplicably plummet a national average of 75 cents a gallon during the final two months leading up to the election. I’m not a big fan of conspiracy theories, but if oil industry executives wanted to do their best to prop up the corporatist-sponsored Republican leadership… this was a great way to do it.
And now that election day has passed? Hmm. Well I don’t know about your neighborhood, but prices here in South Seattle started rising within days, and are already up as much as a dime a gallon at some stations. And a little bit of Googling finds prices up in Oregon and California as well. I’m just sayin’.”
And here’s what the consumer advocate’s group UCAN (Utility Consumers' Action Network) recently said about the last assertion:
“On a per gallon basis, oil prices have dropped by 20¢ since December 21 (2006), yet gas prices have only dropped about a penny during the same time period. If San Diego had competitive fuel markets, our prices would be dropping like a box of rocks right now, yet our gas prices are glued into place. Why? Blame it on what economists call "sticky" prices. A "sticky price" is a price that does not respond to market conditions. And when it comes to being sticky, our gas prices have the staying power of superglue. That's why UCAN has repeatedly asserted that there is no free market for gasoline in California. Prices are set not by the laws of supply and demand, but by the pricing managers at California's seven largest oil companies, ‘The ‘Seven Sisters.’ ” http://ucan.org/gas_autos/why_gas_prices_should_be_dropping_like_a_box_of_rocks_but_arent#comment-38
Yet the pre-eminent (and liberal) economist John Kenneth Galbraith reminds us: “The conventional wisdom serves to protect us from the painful job of thinking”, and that “Among all the world's races, some obscure Bedouin tribes possibly apart, Americans are the most prone to misinformation. ... so much of what they themselves believe is wrong.” And so the thesis of this monograph is set: These “conventional wisdoms” about oil companies, gas prices, etc. are mostly wrong, and the result of a failure to understand the basic principles of economics and how markets operate. U.S. oil and gasoline prices result primarily from the kinds of supply and demand forces that affect all other commodities, rather than government/business conspiracies and market manipulation.
So let us consider the “truisms” as identified above. In fact, there seems to be some validity to those five claims. As with so many misunderstood issues, there are kernels of truth inside of (and partly responsible for) what developed into larger, corrupted, exaggerated “truisms”. This monograph will seek to identify some legitimate criticisms of Big Oil, government, etc., but without the shrillness, hyperbole and, well – the certainty. A key point here will be that things are just not so black and white; reality is complicated. “It’s all a conspiracy; everything Bush does is to make his oil buddies rich; the consumer doesn’t have a chance; we’re being ripped off by the oil companies” You know, none of it is really quite that simple!
This paper will look at data and graphs. It will consider key factors that have impacted the supply and demand for crude oil recently, the elasticity of supply and elasticity of demand for oil and gasoline, the price of gasoline in San Diego relative to nationwide gasoline prices, crude oil, to other commodities, and to overall prices. This will then give the reader some intelligent bases to evaluate “the conventional wisdom” about oil and gasoline prices and draw his/her own informed conclusions.

THE CRUDE OIL MARKET

OVERVIEW
In the last five years, the price of oil rose from about $20 a barrel ($20/bbl.) to well over $70/bbl., before dropping down to about $50/bbl., and then surging again well into the 70s lately. Most of this large price increase can be explained by looking at what has happened to the demand for, and the supply of, crude oil.
DEMAND CONSIDERATIONS
Demand is defined as the quantity of a particular good or service that consumers are willing and able to buy at various prices. For most goods (crude oil included), as prices drop, people generally buy more of the item and as the price rises, they buy less of it. Demand has five different determinants which, blessedly, all just make common sense. Consumer income: ceteris paribus (all other things being equal), the more income people have, the greater their demand for an item; if consumer incomes drop, so does demand. Tastes: the more popular something becomes, the greater the demand for it, and vice versa. Number of buyers: the more buyers there are in a particular market, the greater the demand for a given item. Other goods: if there are substitutes for an item, that can reduce demand for the item in question; also, changes in complementary goods’ availability and prices (think cars and tires, peanut butter and jelly, computers and CDs) can raise or lower demand for an item. Expectations: These could include just about anything. For example, if people expect a shortage in the future, their demand today will rise; or if they expect they may lose their job soon, their demand will decrease.
Oil is used in a vast number of ways, transportation being merely the most obvious. People drive their cars, their SUVs, their trucks, and their RVs using oil. Trains, planes, and ships transport people and goods using oil to propel them. But we also heat our homes and businesses with oil, make paints, plastics and synthetic fibers using oil, use oil-based fertilizers to grow our food. It is no exaggeration to say that ours is an economy and culture absolutely dependent upon oil and its derivatives. This critical market has benefited, if that is the proper word, from increased demand related to each of the five determinants introduced above.
In the United States, a strong economy (GDP has grown over 20% since 2002, or an average of over 3% real – adjusted for inflation - GDP growth per year) has led to increased consumption of oil for all of the purposes mentioned above. Since the US is the world’s largest oil consumer (we use more than three times as much oil as China, the #2 oil consumer, per the CIA factbook, 2005), our insistence on driving gas-guzzling SUVs and our ever-growing consumerism madness have translated into a strong demand for oil, even at higher prices. From about 18.5 million barrels a day in 2002, U.S. crude oil consumption rose to just over 20 million barrels a day in 2004, and 21.9 million barrels a day in 2005. http://www.gravmag.com/oil.html#consume And while higher prices reduced the consumption of some petroleum derivatives, overall imports of oil rose to an average of 10.4 million barrels per day in July, 2006 (when oil prices were their highest), up 1.8 % from a year earlier. http://api-ec.api.org/Newsroom/ monthlystatsjul06.cfm? renderforprint=1
The U.S. is, as they say, the engine that drives the world’s economy. When our economy is strong, its demand tends to bolster the economies of other nations. But that dynamic is changing, as other parts of the world gain in economic strength relative to the U.S. In 2005, the most recent year for which complete data is available, the world’s real GDP rose a sizzling 4.7% (CIA factbook, 2005), led by China (up 9.3%) and India (up 7.6%). Those two nations represent another key to the strong demand for oil. With a total of well over 2 billion persons, China and India are in the midst of a mad capitalist dash to join the developed world. Millions of jobs have been exported to these two nations from the U.S. alone in recent years; GDP per capita and other measures of wealth are skyrocketing. While China’s population has grown only slightly in the last 15 years (from 1.17 billion in 1992 to 1.3 billion in 2005), its GDP has risen from about $3 trillion yuan to about $18 trillion yuan in the same period! http://en.wikipedia.org/wiki/Image:Prc1952-2005gdp.gif Not surprisingly then, China and India, which consumed less than 6% of the world’s oil in 1993, now take about 12% of global oil production. (Bank Credit Analyst, 2007)
What all this means is an increase in the demand for oil, resulting from increases in world income, increases in the number of buyers of other (related) goods, such as automobiles and manufactured goods worldwide, and tastes (as it is fashionable to own a car and participate in frenzied consumerism in more and more parts of the world). Demand has also benefited from expectations that oil might become less available a number of times in recent years. These expectations will be covered more fully in the section on the supply of crude oil. But essentially, they boil down to buyers fearing disruptions in the availability of oil from places such as Iraq, Nigeria, and Venezuela. Additionally, 2005 and 2006 saw a general acceptance of the idea that world oil production had peaked, or was about to peak, and that new supplies of crude oil would be harder to find in the future. These expectations caused a degree of panic in buyers, who rationally sought to protect themselves by buying large amounts of oil in the futures markets before prices headed even higher. This buying was, in turn, exacerbated by speculators who, anticipating higher oil prices, bought additional futures contracts with the expectation of making big profits. There are tens of thousands of oil market speculators, very few of whom are oil company insiders. They are, instead, merely people trying to make a buck by betting on the oil market’s future direction – by watching geo-political developments, forecasting weather changes, reading technical reports and charts, betting on a hunch, etc. If they’re right, they could make a lot of money; if not, they stand to lose a lot.
So the demand for oil increased steadily in recent years, while spiking dramatically higher at times. Another factor in the demand for oil merits consideration here: the demand for crude oil (and its derivative products, such as gasoline) is relatively price inelastic. This means that changes in price don’t have a large impact on the quantity of oil demanded. An easy way to understand this is your own demand for gasoline. Suppose your gas tank is almost on empty, and you need to get to work. You’re going to fill up your tank at pretty much whatever the price is. If you have to pay $2 a gallon, so be it; $3 a gallon, OK; $4 a gallon, ouch! – but you still do it. Your options are essentially non-existent, at least in the short run. The same thing is true with heating oil. It’s a cold winter and your home is heated by oil; you might lower the thermostat a little, but basically you pay whatever the price for heating oil is! And so when the price of oil goes up, people don’t cut back their consumption of it very much. Over time, you can switch to a more fuel-efficient car, ride your bike to work, get a job closer to your home; you can install a wood-burning stove, improve your home’s insulation, and so forth. All of those things decrease the demand for oil in the long-run, but don’t help the immediate picture much. The result is a demand curve (showing the quantity of oil demanded at various prices) that is relatively vertical, as shown on the next page:

Figure 1

SUPPLY CONSIDERATIONS
Supply (the amount producers are willing and able to sell at various prices) is the other half of the equation that determines the price of crude oil or any other commodity. The supply for any item is also determined by five factors: The first is number of sellers (generally, the more businesses producing an item, the greater the supply of the item). Costs of production are another determinant, with the rule being that the less it costs to produce an item, the more of it will be produced and offered at a lower price. Technology has been a great source of additional supply in the oil (and other) markets, as improved technologies allow companies to access previously unprofitable oil supplies, and to more efficiently produce, transport, and sell oil. The profit potential in other markets is a factor as well; if companies see greater profits in selling other items, they will shift their efforts to those markets, thus lowering the supply of the item they had previously been selling (and vice versa, of course). Expectations, as with demand, are the big wild card. Seller expectations that demand will rise or fall, that wars may break out or wind down, that hurricanes may hit or miss oil producing areas, that countries may nationalize their oil industries – or any of a vast number of other possible scenarios – can cause sellers to dramatically change their minds about how much oil they are willing to sell at a given price.
In the last few years, the supply of crude oil has been negatively impacted most by changes in the number of sellers and expectations. Overall, supply has steadily increased over the years; from 66.6 million barrels/day in 1990 to 80 million barrels/day in 2003. http://www.eia.doe.gov/oiaf/ieo/oil.html Yet recently, wars and terrorist activity have reduced the production capabilities (a variation of the number of sellers factor) in Iraq and – to a lesser degree - Nigeria, both of which are large crude oil producing nations, while hurricanes have crippled, at least temporarily, production in the Gulf of Mexico. These developments, along with the uncertainty associated with Venezuela nationalizing its oil industry, have reduced the supply of crude oil rather sharply at times, usually exacerbated by sellers’ fearful expectations that the situation might deteriorate even more.
Supply has also been impacted by the recent publicity and widespread acceptance of reports showing that the world’s oil production possibilities have about peaked and will soon start an inexorable and permanent decline. The thesis – proffered by a number of industry experts – is that by now, most of the easily accessible (read: cheap) oil deposits have already been discovered and tapped. http://www.hubbertpeak.com/summary.htm From now on, we’ll only be able to produce more oil by using increasingly costly methods. Therefore the era of cheap oil is over, we increasingly heard in 2005 and 2006, and we’ll look back at $60 or $70 oil as “the good old days” before too long. However true this proves to be, it did change producers’ expectations about future oil prices, and convinced many that they should be in no hurry to sell their dwindling reserves of black gold.
Like demand, the supply of oil tends to be price inelastic, and a large increase in price only results in a modest increase in the quantity supplied. On a graph as shown here, then, the supply curve for oil is relatively vertical. Simply enough, this inelasticity and rather vertical supply curve is because most suppliers are producing at or near their maximum capacity most of the time. Unlike the production of manufactured goods such as, say CDs for a newly popular musical artist, where supply can easily be ratcheted up from 1000 a week to 10,000 a week, suppliers can’t just turn on a spigot and double their oil production. In order to increase production markedly, they would need to find and drill new oil fields. High oil prices do indeed cause this to happen, but results take many months or years. As with so many other commodities, high prices normally cause big increases in supply – and sharply lower prices – but not right away.

SUPPLY + DEMAND = PRICE
Putting the supply and demand factors discussed above together means significantly higher prices. Supply rises steadily, but is subject to downward “shocks” that are not found in demand – which only seems to increase. But how is it, conspiracy believers persist, that a 10% increase in demand or a 15% decrease in supply could possibly explain a 100% increase in price? Well, because of the market’s elasticity, that’s how! As shown on the next page, a relatively small increase in demand causes large oil price increases, given supply’s inelastic structure, and a small increase in demand causes large prices increases, given oil’s inelastic demand structure. Higher demand with lower supply, in an inelastic market? MUCH higher prices! It is beyond the scope of this paper to take a detailed look at actual supply/demand numbers, ascertain precisely the elasticity coefficients for oil, and attempt to identify appropriate price levels. Were one to do so, it may well turn out that prices did, in fact, rise more than would have been justified by the market mechanism. Thus, the opportunity for unjustifiably high prices seems quite possible. Proving that prices rose more than what supply, demand and elasticity coefficients would justify is a fairly tricky matter however, so it must remain merely a suspicion, barring more conclusive evidence.
Whatever the justification for sharply higher prices, it’s clear that they resulted in gargantuan profits for oil companies. But it’s important to be clear about cause and effect here. Because the oil companies benefited from higher prices doesn’t mean that they are responsible for those higher prices, as so many people simplistically believe. The Foundation for Taxpayer and Consumer Rights (FTCR) pointed out in April of last year, for example, that: ”The profit increase of 42 cents, on top of record profits last year, means California gasoline will cost consumers approximately $546 million more in April 2006 than in April of last year….the chief cause is increased profiteering by oil companies that have previously posted world record profits," http://www.consumerwatchdog.org/energy/pr/?postId=6133 While it may be that oil companies have acted unreasonably to boost prices and thus profits (as profiteering implies), it does not have to be the case: a crucial distinction that many people apparently fail to appreciate. In fact, there seems to be a lack of hard evidence to support such claims, as discussed later in this essay.
In economics-speak, the market mechanism (when supply and demand interact) serves to allocate scarce resources. What this means here is that when oil becomes scarcer due to supply problems exacerbated by persistently increasing demand, prices rise. As they rise, some people are more willing to pay the going rate than others. With demand for oil being price inelastic, prices have to rise quite a bit to get people to drop out of the competition. So it is essentially buyers, bidding against one another, that set the price in this situation; the highest bidders get the “scarce resource” and therefore largely determine oil companies’ profits. Again - just because they’re making huge profits doesn’t mean it is the oil companies that caused the higher prices behind them. The silver lining about higher oil prices is that they send the message that people need to reduce their demand for oil and its derivative profits; over time, people do, and that’s a good thing.
Another key part of the allocative function of the market mechanism results from the increased profits that come with higher prices. Since oil companies make tons of money with higher oil prices, they are both willing and able to invest much more in finding and producing more oil. ExxonMobil is the world’s largest energy company. Its spending on exploration increased to $19.1 billion last year, an investment easier to make because of its higher profits. http://www.washtimes.com/op-ed/20060710-082053-1657r.htm Furthermore, high profit levels attract new competitors to the industry. Consumers will benefit from all this as new oil supplies come online in future years, just as higher oil prices in the late-70s and early-80s led to new supplies and much lower oil prices in succeeding years.

Figure 4

Exxon-Mobil S&P 500 1985-2000

Referring again to the seemingly obscene oil company profits (e.g. $39.5 billion for Exxon-Mobil and $24.5 billion for Royal Dutch Shell), one also needs to place these profits in perspective. The fact is that oil companies have invested immense sums of money in finding and producing oil over the decades. Nobody complained when oil prices were weak (1985-2000) and oil companies were barely profitable. Few critics care that oil company returns on investment were below average (relative to all U.S. industries) for that period, and nobody was crying for government intervention to help struggling oil companies. One way to see this is via the graph shown above; it compares the price of Exxon-Mobil stock to that of the S&P 500, the widely-followed proxy for the stock market as a whole, and shows that the S&P 500 rose nearly 800% from 1985-2000, compared to Exxon-Mobil’s increase of less than 700% in the same period. Even recently, the 5.9% profit made by energy companies from 2000-2005 doesn’t seem so outlandish compared to the 5.2% average of all industries. (U.S. Census Bureau). Granted – 2006 was a monster year for them, yielding profits well above most other industries, and it was this one year that’s gotten everyone’s attention. But a little perspective is helpful…..

Figure 5

One could suggest that conspiracies and market manipulation have exacerbated the market’s mechanics, yet conspiracies and manipulation – if they exist - are not necessary to explain the higher prices. A look at the price history of other commodities shows that crude oil acts pretty much like the market for any other valuable resource. The graph to the right shows what the oil market has done over the last 9 years:

N.Y. LIGHT CRUDE OIL

Figure 6

Compare that to the copper market over the same time period:
N.Y COPPER, sometimes referred to by economists and commodity traders as “Dr. Copper” for its importance in identifying overall strength or weakness in the economy, is a critical component of the automobile, housing, and electronics markets. With its price soaring even more dramatically and persistently than oil’s price, should we infer that even greater manipulation and conspiracies exist with the world’s copper producers?

Figure 7

Here’s another market over the same time period:

CME PORK BELLIES:
Look at those price swings - so much more volatile than crude oil! Pig farmers of America involved in market manipulation also – et tu, Porky???

And then there’s the market for commodities as a whole. As a group, commodities (raw materials) tend to be price inelastic for both supply and demand, just as oil is.

Figure 8

CRB INDEX
As shown on this graph of the CRB Index, which includes grains, meats, metals, foods, fibers, and energy markets, overall commodity prices have soared over the last few years. Could it all be just one big conspiracy, by all of the world’s millions of producers of all of the world’s key raw materials? One supposes that anything is possible, but this doesn’t seem likely.
The truth is that none of these markets is particularly prone to price manipulation, since they are huge, worldwide markets that are beyond the control of any one seller, nation, or group of sellers in the long-run. No more proof need be offered than the case of OPEC (Organization of Petroleum Exporting Countries). OPEC members produce about 40% of the world’s oil, and account for about 70% of the world’s known oil reserves. Yet even this powerful cartel was helpless against the worldwide disinflationary trend of the mid-1980s, as oil prices dropped from $50/bbl. to $10/bbl., severely damaging the finances of OPEC members.
A more realistic alternative to the manipulation theory would be that markets move up and they move down, often dramatically and often erratically, in response to very complicated interactions between ever-changing supply and demand dynamics. That’s what has been going on with copper, with pork bellies, and – yes – with crude oil. Furthermore, there has been profound strength in the prices of ALL raw materials worldwide in recent years, a trend in which crude oil is but one of many participants.

Figure 9

THE GASOLINE MARKET

As a derivative of crude oil, the largest single determinant of gasoline is the price of the oil used in making it. In 2005, 55.6% of the retail price of a gallon of gasoline came from the cost of crude oil. The remainder went for refining, shipping, and marketing the gasoline (28.3%), and for taxes (16.2%.) (US Dept. of Energy, U.S. Department of Labor, American Petroleum Institute). Refining, shipping, and marketing costs “normally” don’t change very much or very rapidly; taxes on gasoline change even less often. So it’s a pretty safe bet that most of the movement in gasoline’s price is due to changes in the price of crude oil – most of the time. The above graph shows that this has been the case for the past 50-some years. Sometimes gasoline prices go up more than crude oil prices, sometimes not as much, but they track each other pretty closely overall. One notable exception is the period from the about 1984 to 1999. Oil prices mostly moved sideways, while gasoline prices trended somewhat

Figure 10

higher during those years (starting out around $1/gal. and ending up around $1.25/gal.). Without exploring in detail the reasons for this divergence, it is likely that a good chunk of this difference came from increased taxes on gasoline. In 1981, taxes accounted for just under 10% of gasoline’s cost, compared to the 16.2% figure in 2005. (US Dept. of Energy, U.S. Department of Labor, American Petroleum Institute)

Gasoline prices are determined largely by the same kinds of supply and demand considerations discussed earlier for the crude oil market.  Perhaps even more than oil, gasoline is price inelastic in terms of its demand and particularly its supply, especially in California.  As mentioned earlier, drivers’ demand for gasoline changes slowly, and they make only minor changes in the quantity purchased when prices rise, even when they rise rather sharply.  And in how many other markets are prices clearly displayed on street corners for consumers to compare?  To quote The College of William and Mary’s economics professor Dr. Olivier Coibion, “Even if one gas station tried to price gouge by raising its prices disproportionately to costs, other gas stations would have tremendous incentive to not do so, and steal customers.  Because gas prices are so visible and competitive, the idea of major price gouging by gas stations is total nonsense.”

On the supply side, refineries (especially in California) tend to operate at very close to capacity, meaning that they are often unable to boost supply significantly, even to take advantage of much higher prices. Critics have suggested that oil companies have closed some California refineries specifically to keep the state’s gasoline prices artificially high. Perhaps that is true, or perhaps the companies have other legitimate reasons for the refinery closings, as they claim. Refiners also claim that they have a huge incentive to produce as much as possible when prices are high, not shut down refineries then.
But in any event, closing refineries is not illegal or an infringement upon consumers’ rights, but rather a business decision that is theirs to make if they so desire. And in any case, the bottom line is that with inelastic supply and demand curves, any increase in demand or reduction in supply causes a magnified increase in gasoline prices, similar to what was shown in the section on oil prices.
In 2005, Katrina and several other extraordinarily powerful hurricanes hit the industry after it had already been stretched to capacity by steady increases in demand. Having virtually no spare productive ability, Katrina knocked out more than 25% of the U.S.’s oil production, and 10-15% of its refinery capacity. Additionally, major pipelines to various parts of the U.S. were crippled or totally shut down for a significant period of time, further limiting the availability of gasoline nationwide. Thus, gasoline prices soared across the U.S., and some stations actually had no gasoline at all for awhile - a good example of what happens when inelastic demand meets decreased and inelastic supply. (http://www.eia.doe.gov/bookshelf/brochures/gasolinepricesprimer/eia1_2005primerM.html)
The situation in California adds another wrinkle to the gasoline pricing picture. California requires a special blend of gasoline, with a prohibition on the additive MTBE. Ethanol replaces MTBE in California gasoline, and thus the state’s gas is more expensive to produce than elsewhere. Few refiners outside of the state can readily accommodate California’s unique blending requirements, so retailers have hardly any options available when demand rises, or when local refineries experience problems. Some Gulf Coast and foreign suppliers can help, but their long distance from California mean significant delays, greater transportation costs and, therefore, higher prices. The closest acceptable refinery is in Washington, 7-10 days away from California consumers. http://www.energy.ca.gov/gasoline/gasoline_q-and-a.html The Utility Consumers’ Action Network (UCAN) suggests, however, that the state’s blend is being adopted by more and more states in the last few years, making this argument increasingly less relevant. On the other hand, California’s energy commission posits that as other states switch to a similar blend as California, the competition for that still-relatively-unique blend keeps upward pressure on our prices, compared to much of the rest of the nation. Making the issue even more complicated, UCAN claims to have evidence showing that “more often than not, the greater the distance a gas station is from the source of fuel, the lower the price.” http://ucan.org/gas_autos/why_gas_prices_should_be_dropping_like_a_box_of_rocks_but_arent#comment-38 One suspects that other factors (besides distance) are in play to explain this assertion, with collusion being only one possibility. Nevertheless, they give one pause and reason to suspect possible oil company shenanigans.
Also at about the same time Katrina hit in 2005, California temporarily lost the production of two refineries in Martinez (the Bay Area) due to a fire (Tesoro Oil) and mechanical problems (Shell Oil). http://www.signonsandiego.com/uniontrib/20050830/news_1n30gas.html This “perfect storm” of higher demand, unique blending requirements, supply problems in the Gulf, and supply problems at California refineries led to record prices and, of course, cries of unfair market manipulation on the part of oil companies. In May, 2006, a Congressionally-mandated FTC commission on the issue reported that it “found no instances of illegal market manipulation that led to higher prices during the relevant time periods but found 15 examples of pricing at the refining, wholesale, or retail level that fit the relevant legislation’s definition of evidence of ‘price gouging.’ Other factors such as regional or local market trends, however, appeared to explain these firms’ prices in nearly all cases.” http://www.ftc.gov/opa/2006/05/katrinagasprices.htm One supposes that those convinced of government complicity in an overall gasoline price conspiracy would view such findings with great skepticism. As California’s own Senator Barbara Boxer said: "This report proves that this administration is owned and operated by big oil'', which itself is a sad testament to people’s disregard for the true meaning of proof…. http://www.sfgate.com/cgi-bin/article.cgi?file=/chronicle/archive/2006/05/23/BUGK5J097K1.DTL&type=business Yes - it IS hard to believe that the oil companies, or even individual gas station owners, didn’t take advantage of the chaotic situation at least a little by jacking up prices a few more notches, but it’s the actual proof that remains elusive.
It does seem that gas prices go up much quicker and further when things go wrong, compared to their ability to go down when things go right. As mentioned earlier, UCAN claims that these “sticky” prices result from non-competitive actions by the “Seven Sisters” (Arco/British Petroleum, Chevron, Shell, Conoco/Phillips, Valero, Tesoro, and Exxon/Mobil). But UCAN’s absolute assertions about California’s gasoline market, such as “there is no free market for gasoline in California. Prices are set not by the laws of supply and demand,” (gee - not at all?) go too far, and are supported by selected anecdotal evidence rather than unbiased data. Excessive claims such as UCAN’s and Boxer’s play to their already-convinced constituents (aka: preaching to the choir), but lower their credibility with objective truth seekers. According to the state’s energy commission, “Rumors and charges of collusion among the oil companies have been raised for decades with nothing ever proven. Investigations have been undertaken by California Attorney General and by federal authorities looking into these allegations.” http://www.energy.ca.gov/gasoline/gasoline_q-and-a.html. Well OK – so not everybody’s going to believe the government, which is so heavily influenced by big business. Yet, a look at the actual numbers shows that from July to December 2006, average crude oil prices in New York dropped 18%, while average gasoline prices in San Diego dropped 22%. That doesn’t seem so terribly “sticky”, at least not in this most recent case. http://www.sandiegogasprices.com/retail_price_chart.aspx Common complaints such as: “aha! oil prices are down this week and gasoline prices are not. Those damn oil companies!” fail to look at the big picture, the long-run, where these discrepancies tend to even out and display little break in “linkage” (See Figures 9 & 11)
Aside from changes in the price of crude oil and refinery capacity, gasoline prices also fluctuate for seasonal reasons. According to the federal government’s Energy Information Association, gasoline prices normally increase by 10-20 cents per gallon between January and mid-summer, even if crude oil prices remain unchanged, as a result of increased demand for summer driving. This seasonal rise tends to reverse by October, several weeks before the November elections. (http://www.eia.doe.gov/bookshelf/brochures/gasolinepricesprimer/eia1_2005primerM.html)

Gasoline

This brings us to perhaps the juiciest claim: especially under Republican administrations, gasoline prices fall before elections and rise right after them, in order to re-elect Republicans and maximize oil company profits. But to be painfully blunt, this thought seems not so different from those of primitive humans who thought that lightning, comets, and the like were actions of the gods playing around in the skies: when you don’t understand something, blame it on the gods (or the Republicans, in this case). Of course, the seasonal trends, as mentioned above, explain this “election anomaly” more satisfactorily.
But even the initial premise – prices fall before elections and rise right after them – doesn’t hold much water. Figure 11 shows crude oil and gasoline prices since 1982. It confirms the basic relationship between the two: gas and oil prices move closely in tandem. It also shows, however, the nation’s November elections (highlighted). Close examination of the graph, and the summary shown below, reveal that the “election anomaly” is essentially a chimera. Gasoline prices have fallen before the November elections in only 3 of the 13 instances since 1982, and risen after the election only 5 times out of 13. Only twice have gasoline prices clearly trended lower before the election and then higher after the election: once during a Democratic administration (1996) and once during a Republican administration (2006). This is hardly damning evidence of a Republican plot to win re-election while lining the pockets of Big Oil.* All things considered then, the dispassionate observer might reasonably conclude that manipulation, collusion, and price gouging can explain only a small part of the California market’s dynamics at best.

Figure 11

Crude Oil

Figure 12

GASOLINE PRICES v. NOVEMBER ELECTIONS
YEAR ADMINISTRATION TREND BEFORE TREND AFTER
1982 Republican Down Down 1984 Republican Sideways Down 1986 Republican Sideways Up 1988 Republican Sideways Down 1990 Republican Up Down 1992 Democratic Sideways Down 1994 Democratic Sideways Down 1996 Democratic Down Up 1998 Democratic Sideways Down 2000 Democratic Sideways Down 2002 Republican Sideways Up 2004 Republican Up Up 2006 Republican Down Up
*Data based on N.Y. Light Crude Oil monthly prices http://tfc-charts.w2d.com/chart/CO/M, and gasoline prices from central Texas http://www.randomuseless.info/gasprice/gasprice.html. San Diego gasoline prices (available only for 2004-2007) http://www.sandiegogasprices.com/retail_price_chart.aspx showed little differentiation as far as timing and extent of price changes when superimposed on Texas prices, incidentally.
CONCLUSIONS
(and a rather out of place anti-SUV rant)

Exxon-Mobil S&P 500 2002-2007

There are reasons to think that the oil and gasoline markets are rigged, especially for residents of the Golden State. It’s hard to dismiss all of the indications of oil companies regularly taking advantage of California consumers. Yet real evidence of malfeasance is hard to come by. Many of the commonly held beliefs about gasoline prices, oil companies, and so forth are the result of faulty cause and effect assumptions. People want simple answers for what turn out to be very complex issues.

Figure 13

They tend to grasp at intrinsically appealing but essentially flawed answers that result from an incomplete understanding of how markets actually function, and that fit into Americans’ fondness for conspiracy theories and dislike of Big Business.
Yes, California residents pay more for gasoline than most other Americans, but that doesn’t mean the market system doesn’t work or that the oil companies’ manipulation is behind it all.* Yes, gas prices sometimes drop before elections and rise after them, but that doesn’t mean Machiavellian politics are behind the changes and in fact, prices rarely even do what this conventional wisdom claims they do in the first place. Yes, as the graph in Figure 13 implies, oil companies made un-Godly amounts of money in 2005 and 2006, due in part to their higher refining profits and overall margins. But that doesn’t mean their actions are responsible for the run up in prices or even the higher margins, as the FTCR has claimed. (http://www.consumerwatchdog.org/energy/rp/6132.pdf) Profits that were clearly a result of higher oil prices simply cannot be taken as a priori proof that oil companies created the higher prices.
* Note: Crude oil prices surged to a new all-time high on July 31, 2007 while California’s gasoline prices were 28 cents lower than a year ago, and about 50 cents lower than their all-time highs, due to California’s refineries being “all up and running.” (San Diego Union Tribune, July 31, 2007). This tends to confirm that oil and gasoline prices can diverge widely – in either direction - in the short-run, even as they track each other rather closely in the long run.
Actually, this is what it really boils down to perhaps more than anything else: higher California gasoline prices seem, in fact, to have been tied in large measure to the higher oil company margins. Taking that as a “given”, then the real question is whether those higher profits were a result of the market mechanism seeking to allocate scarce efficiently, based on supply, demand, and elasticity considerations as discussed earlier. If that is the case, oil companies cannot be singled out for “profiteering”. On the other hand, if the market mechanism can be shown not to be the primary precipitator of these higher margins and prices, then vilifying oil companies makes sense and should continue. This is where consumer groups and politicians should focus their efforts: in identifying evidence that will convince unbiased Americans, courts, and other legal bodies.

But either way, we accept that oil companies aren’t really our friends. The oil companies do what they do to make money, and their job is to make as much money as they can (get away with). So they limit supply if that will maximize their profits, and they try to keep prices high, if that will maximize their profits. That’s their raison de vivre. They don’t seem to be acting illegally, or dishonestly, however. So what can we, the lowly consumers, do? Well, we could buy oil company stocks. There is, in fact, no Mr. Mobil, no Mr. Exxon, and no Mr. Shell. All of these are public companies, working for the hundreds of thousands of individual investors who are their owners. The latest statistics show that now more than 50% of American families own stock; it’s not just the wealthy that own these oil companies. http://www.businessweek.com/the_thread/wellspent/archives/2005/11/stock_ownership.html If you think they’re making too darned much money, buy some of their stock and put some of that money in your own pocket!
But low income people, hit the hardest by higher energy prices, can’t afford to buy stocks. So what else can we do? Well, there are some things that almost anyone can do. Oil

Exxon-Mobil S&P 500 2002-2007

companies and gasoline prices don’t operate in a vacuum, after all. To a large degree, Americans have allowed themselves to be held hostage by the power that high gasoline (and other energy markets) prices hold over them, and therefore might blame themselves as much as anyone. Nobody forces Americans to drive a big gas hog 75 or 80 miles an hour on the freeway, which saves them a whole 3 minutes in the typical commute vs. a saner 60-65 speed. It is absolutely maddening how, even with record gasoline prices, Americans stubbornly insist on their God-given right to drive vehicles that are much larger than what most of the rest of the world drives, to drive them everywhere, and to drive them at speeds well above the speed limit – all along complaining about high gas prices! A smaller car could be just as safe and practical (not to mention cheaper) as that recent icon of America’s roadways: oversized SUVs.
The common justification for this fixation on huge, expensive SUVs is that they are safer. The reality is, however, that SUVs started to become popular in the late-1980s with the Jeep Cherokee and later, the Ford Explorer, both mid-sized vehicles that appealed to suburban soccer moms, legitimate outdoors enthusiasts, and those merely posing as rugged and outdoorsy; safety wasn’t really the issue. By the mid-1990s, they seemed to be in almost every driveway. Soon after, hip-hop artists adopted huge luxury SUVs as the way to show off their affluence, and it wasn’t long before regular Americans decided that they too needed the biggest, most expensive and ostentatious SUV they could afford, regardless of its practicality because, after all – “they’re safer”. In the case of a head on collision between a big SUV and a small passenger car, that is probably true. One imagines that most accidents are of another sort, such as being rear ended, sideswiped, rolling over, etc. Overall, SUVs don’t seem to be safer than most passenger cars, as shown in the following table. Whether it’s a luxury Mercedes, a mid-range Volvo, the top-selling Camry, or the best selling American made car (Impala), these cars are as safe as, and generally less expensive than, SUVs, while getting 33-58% better gas mileage!

Data from NHTSA (www.safercar.com) and U.S. Dept. of Energy (www.fueleconomy.com) for 2006. MSRP from various online websites.

Safety (1 to 5 stars)

Model Front Side Rollover MPG MSRP

SUVs

Expedition 5 NR 3-4 12-17 $29,245 - 42,645

Explorer 5 5 3 13-19 25,755 - 35,460

Escalade 4 NR 3 12-16 54,045 - 58,990

Tahoe 4 NR 3 14-19 34,095 – 38,950

Armada 4-5 NR 3 12-17 35,250 – 44,550

Passenger cars

Mercedes E class 4 5 5 15-25 50,550 – 85,400

Volvo S40 4-5 5 4 19-28 24,240 – 28,990

Camry (#1 seller) 5 3-4 4 18-31 18,470 – 28,020

Impala (#1 U.S. made) 5 4-5 4 16-28 21,015 - 28,040

So it is a chimera, this fascination with big gas swillers favored as much by low-income Americans to show they’re cool, as by the wealthy to show they’ve got money to waste. But to finally move on from the SUV rant, nobody forces Americans to live 15 or 30 miles from where they work, to not car pool, to not take public transit; these are things we could do something about, if we really wanted to. Nobody forces Americans to adopt the insane mentality that leads them to pay $100 a month to join a gym, and then drive their car half a mile to get to the gym (or the post office, a friend’s house, or anywhere else). Aside from giving the rest of the world another reason to make fun of Americans, this kind of activity merely confirms that we deserve some of the grief that higher oil prices have brought.
But what most people do instead is just bitch about how they’re getting ripped off – blaming someone else, in other words, and demanding that the government “do something”. That “something”, more often than not, is to increase oil company taxes, or simply reduce the amount of taxpayer-provided subsidies they receive. As emotionally alluring as that idea is, reducing oil company profits also reduces the long-term benefits to society that those profits indirectly create (as discussed earlier), and should first be carefully considered. Another option would be to impose a maximum price on gasoline and other oil products, thus limiting corporate profits while protecting consumers. While an intrinsically appealing idea, history shows that such a price ceiling often creates as many or more problems for consumers (e.g. shortages, hoarding, and black-market activities) than it solves.
And we can all support what UCAN, FTCR, and other watchdogs do: they keep a close eye on oil companies to make sure they don’t get away with any more than they should. We can keep pressure on elected officials to continue monitoring the oil companies and investigating possible wrongdoing. But we also can and we should demand that consumer watchdogs identify and present more high-quality evidence of wrongdoing, and less superficial “proof” that serves mostly to keep their base fired up.
We should also realize that the vast majority of the blame for higher gasoline prices rests not with the oil companies or gas stations, but with us and the choices we’ve made in the past, and which we continue to make today. Americans can change many of those choices pretty much at will, by car pooling, riding a bike to work one day a week, getting a more fuel-efficient vehicle, driving 60 mph on the freeway vs. 75 mph, and other relatively simple changes to their daily lives. Maybe those things are not as easy or as much fun as blaming someone else, but they match up better with reality and have a chance of actually making a difference.
Jon S. Strebler
August 2007