I have an essay on conservation ready to go, with some discussion of how Europe deals with high gas prices. However, a couple of newsworthy items are worth commenting on. The Oil Drum beat me to the punch on Chuck Schumer’s grandstanding, but another article caught my eye yesterday.
I read a news release from published a study (if you can call it that) by Tim Hamilton, in which he concluded that “corporate markups and profiteering are responsible for spring price spikes” (2). Hamilton claims that the oil industry has blamed 3 factors for rising gasoline prices. They are:
1. Higher oil prices.
2. Higher costs for reformulated gasoline.
3. The switch from MTBE to ethanol.
He then goes on to attack each factor, trying to “prove” that the biggest reason for higher gas prices is none of these, but instead increased profiteering. However, Hamilton is certainly not telling the whole story. He is out to get the oil industry to satisfy a political agenda, and probably feels like the end justifies the means. But here is what he forgot to tell you.
The oil industry has also blamed another factor, consistently and with good reason, since Hurricane Katrina struck. While the 3 factors mentioned above have played some part in higher gas prices, none of them are the biggest culprit. The biggest culprit is that refining capacity has struggled to keep up with demand since the hurricane. Gasoline inventories continue to fall week after week, despite the higher prices. That means that prices still have not been increased to a level sufficient to stem demand. As long as gasoline inventories continue to drop, prices will continue to go up. If they don’t, shortages will eventually result.
Here is a graph showing refinery utilization before and after Hurricane Katrina:
Source: American Petroleum Institute as published in the Oil & Gas Journal Statistics
It is clear that we have yet to recover refining capacity to the level it was before the hurricane. What this means is that we have a problem with supply and demand, which means prices will rise as they are doing to prevent shortages. (What Chuck Schumer thinks it means is that refiners are deliberately withholding product from the market).
Even so, gasoline inventories continue to fall, as they have been doing for seven weeks straight:
Source: This Week In Petroleum at http://www.eia.doe.gov/
Gasoline stocks are in free fall. Again, I have to wonder if Mr. Hamilton is completely ignorant of supply and demand. As long as the stocks continue to fall, prices will continue to rise.
Now, nobody is denying that this has resulted in higher profits for oil companies. That is what capitalism is based upon: Supply and demand. It seems like many people do not understand basic economics. When someone has a resource, and demand goes up, prices will increase until supply and demand are balanced. If the resource was not scarce, then the supplier couldn’t raise prices, because someone else would continue to sell at a lower price, and could steal the customers. Hamilton and others have completely mixed up cause and effect. The cause of higher gas prices is not increased profiteering. The cause is very tight supply, with some contribution from the other factors mentioned above. The effect is that oil companies are making more money.
Hamilton was not alone in his cluelessness. From the same news release:
“Oil companies are opportunistically using the rising world price for crude oil as an excuse to excessively raise gasoline prices and pump up their profits, even though the spot market price for crude has gone up far more slowly than gasoline prices,” said FTCR President Jamie Court. “In addition, the spot price is higher than most oil companies pay, since they either harvest their own crude or pay more stable and often much lower contract prices.
“This study should be a wake-up call for California voters who will vote in November on a ballot initiative to tax windfall profits by oil companies so the state can develop alternatives to the petroleum economy.”
And there we have the money quote. The FTCR wants to punish the oil companies for making money, and they want to funnel the money to a competing industry. They are using this misleading study to push their political agenda. Now, I am all for alternative energy. I have made that abundantly clear. But the ethanol industry already benefits from very generous subsidies, and the energy they produce is trivial with respect to the size of the subsidy. Yet somehow, the existing subsidies and mandates are still not enough. Shouldn’t that trigger a flag in people’s minds that something is not quite right here with ethanol economics? I would be willing to bet that >90% of the voters don’t understand why there is controversy surrounding the use of grain ethanol as a fuel. I bet the FTCR doesn’t understand the controversy. They think it is a good idea to punish oil companies and they think they know where the money should go.
The person bankrolling this initiative , Vinod Khosla, is a major investor into the industries that would directly benefit if the initiative is passed (3). Doesn’t anyone see a problem with this? Isn’t there a conflict of interest here, which may prevent a much better solution from being enacted? Here is a man who stands to gain millions if he can just convince the voters to punish the oil companies and send that money his way. If you are going to pass a windfall profits tax, why not use the proceeds to give rebates for the purchase of very fuel efficient vehicles? Wouldn’t that be a far wiser use of the money, with immediate benefits?
There is too little personal responsibility here. People can “punish” the oil companies by avoiding long commutes, buying a more fuel efficient vehicle, and reducing unnecessary driving. The FTCR would instead absolve people of their personal responsibility and blame it all on the oil companies. But the reason oil companies are so profitable is that the American public has an insatiable appetite for energy. Shifting money from one industry to another – especially one as inefficient as the production of alcohol from grain – is not the answer. The results will be less money for capital projects, which will lead to fuel shortages and ever higher prices. Didn’t we learn that the last time around?
1. New Gasoline Study Shows Profits, Not Crude Oil Prices Or Ethanol, Are Driving Pump Price Spike
2. Why Gasoline Prices are Headed for $3.50 at the Pump
3. “Valley man bankrolls clean-energy initiative.” The Mercury News, April 3, 2006.
11 thoughts on “Another Uninformed Consumer Watchdog”
I’ve been reading your blog for a little while and found it very interesting and well-thought.
I do have one question about the economics of oil. While I understand how U.S. refinery capacity can affect the price of gasoline at the pump, what I do not understand is how it can be said to affect the price per barrel of crude. My limited understanding would seem to suggest that if refinery capacity drops, then demand for crude also would drop because we don’t have the ability to process it. Thus, the rise in the price of crude would have to have some cause completely unrelated to U.S. refining capacity.
Am I wrong? What am I missing?
You are correct. Technically, limited refinery capacity should only affect the price of crude by making it drop. I have been expecting crude prices to drop for a while, because crude inventories are very high across the country and have been building. But there is so much nervousness in the market (and not much excess capacity), prices have remained high. Yet from a simple supply and demand view, crude prices should be lower because crude inventories are well above historical values.
I recently came across your blog while reading Oil Drum threads, and I enjoy your insightful posts.
One suggestion: consider putting a link up to your XML/RSS feed. I guessed that you might have one at
because you use Blogger (as do I). People like me can then get your content using XML/RSS-to-email (like Feedblitz)
Near the top of your entry, I think that this is backwards…
3. The switch from ethanol to MTBE.
Hi, I think I understand supply and demand all right, I took economics in college… but I still am confused by the profits spike following Katrina… That prices increased is no surprise, but earnings depend on volume as well as price. If a decrease in production capacity results in greater profits for oil companies, doesn’t that mean they were over-producing before? If so, why?
That is true if prices go up directly in proportion to the lost volume. But that isn’t necessarily true. After the hurricane, 25% of the U.S. refining capacity was lost for a while. It took some pretty steep price hikes before demand was stemmed enough that refiners were no longer worried about running out of product.
The other thing to consider is that refiners were sitting on some level of inventory. That inventory started getting pulled down after the hurricane. Refiners can continue to supply the market for a while (even if there was no production) for a short period of time, but they will have to raise prices to stop the inventories from being pulled all the way down.
What about the theory that we are currently experiencing a glut of heavy, sour crude, and that there is actually a lack of higher API oil which is more easily converted into gasoline? This would explain higher stocks of oil and higher gas prices. I’ve been waiting to see some proof of this over at TOD, but I may well have missed it with the high volume of posts there.
It would be nice to see both Schumer and Pelosi quit grandstanding and making political points, and instead do something proactive to actually help the situation.
For example, Schumer could try to make it easier for oil companies to build new refineries on the east coast — perhaps on Long Island. If my information is correct, there hasn’t been a new refinery built in the U.S. in over 20 years because of the many regulatory hoops anyone thinking about building a new one must jump through. Immediately after the “twisted sister” hurricanes last fall, there were several stories about a company trying to build a new refinery in Arizona. There were about ready to give up in frustration because of all the permits they needed and the resistance they were facing.
Both Schumer and Pelosi could also change their views on ANWR. ANWR isn’t the ultimate solution, but it would help. Had we started on it five years ago, it might provide just enough extra supply now to delay peak oil a few years.
They could also change their views about drilling off the coast of Florida and California. I recently read there is a potentially large oil field in the deep Atlantic off the Carolinas that we will probably never touch because of enviro concerns. It would be costly, but probably no more so than the North Sea oil fields the UK and Norway have run well.
Unfortunately, it is much easier to hold press conferences about price gouging instead of presenting a positive solution.
With the site meter at the bottom, you can click on it and get various information about the users. Last night, someone came to my blog by doing a Google search of your name and ethanol. If I recall correctly, they were from Missouri. Have you been antagonizing those Missourians with your ethanol bashing? :^)
Bryan, one thing I have pointed out is that if refiners are stockpiling heavy, sour crude, then that means they can process it. There is definitely tightness in the gasoline market. I think the oil market is not nearly as tight, but the oil market is very nervous. I would say there is little spare capacity in the oil market, and no spare capacity in the gasoline market. And yes, there probably isn’t as much light, sweet crude out there as refiners would like.
I would blame the consumer a little less. Consumers certainly haven’t gotten a clear message about the need for efficiency until very, very recently. Remember how Bush used a gas tax proposal against Kerry? Also, I’d put a little less emphasis on consumer-driven demand for light trucks. While it is true that advertising has it’s limits, it’s also more powerful than we like to admit sometimes.
Detroit had cheap light truck capacity, and sold the public on light trucks as a status symbol, and psychic protection from danger (i.e., SUV’s feel big and safe, even though they aren’t…). This allowed them to compete effectively against imports with lower labor costs. Certainly the public had to go along with this, but the public didn’t really start this.
Of course, it certainly helped that the CAFE loop-hole allowed marketing of SUV’s as sportscars…
An illustrative story of the power of marketing is diamond engagement rings in Japan. 40 years ago they were unknown, just not in the culture. deBeers marketed the heck out of them and now diamond engagement rings are de rigeur.
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